As the current financial year draws to a close, it is worth introspecting on the changing preferences of small investors and attempt to look for patterns and trends driving the change. whose investments and returns have seen a roller coaster ride against the changing macroeconomic backdrop.
The beginning of financial year gave first signs of economic slowdown, In the first quarter of fiscal year 2013/14, GDP grew at disappointing 4.4%. Inflation was stubbornly high, The CPI inflation hovered around 10.24%.The currency value of Indian rupee against dollar slipped to its all time low of Rs 69 during the year, also the persistent current account deficit on account of huge gold imports invited regulatory action of hiking import duties on yellow metal and imposing quantative restrictions on its imports. Much to their chagrin small investors who looked at gold as a safe haven for investment and hedge against inflation soon discovered that this asset class which had outperformed in the last few years would soon start losing its sheen.
Gold as a financial Asset
The lure for the yellow metal for the Indian investor is not new. The cultural milieu of Indian masses has always made gold as an attractive store of value . However post 2008, after the financial crisis of US, when investors started seeing erosion in their dollar denominated wealth, the appeal for gold increased more than ever before. Across the world with weakening of the strongest currency-the US dollar, investors started turning to gold a safe investment option. Even before the beginning of financial crisis, gold was outperforming. The super cycle of commodities that had been on account of various factors such as FED quantative easing, China and emerging markets growth story, had seen a meteoric rise in commodity prices , where investors had begun “financialisation of commodities” gold too was not an exception. In India which had a huge market for jewelry too was seeing a paradigm change and consumers had begun looking at gold as an investment option. Gold unlike many other asset classes offer these unique advantages
- It acts as a hedge against inflation
- It insulates the investors against currency depreciation
- It acts as a refuge against economic and political turmoil.
- It’s a store of value for the cash economy especially in rural India , which hitherto is still some distance away from financial inclusion.
The psyche of the small Indian investor suited gold; whilst real estate has always created wealth; the myriad issues of large outlays, complex holding patterns, inheritance issues coupled with illiquidity made the small investor shy away from it. Gold on the other hand offers sensory pleasure (“I-can see-touch-and hold it”) can be bought in small quantities and above all can be encashed even in the middle of night makes the appetite for gold almost insatiable.
A large number of avenues such as Gold ETF , commodity derivatives, gold coins against the traditional jewelry added to where consumers could avail the high returns of yellow metal. As seen in the graph below the upward climb in returns of gold continued from to till July 2013.
Graph1: Daily Prices of Gold Rs/10gm: 2008-2014
As per the CSO estimates between 2007-08 and 2012-13, investment in valuables –gold and other precious metals, including jewellery increased five-fold from 53,592 crore to 266,482 crore.
On May 22nd. 2013, on the announcement of tapering of quantitative easing by the U.S. Fed, gold became the biggest loser internationally. However, Indian investors were still protected because of rupee depreciation, and still high inflation. The capital flight and the looming problem of current account deficit which was weakening the rupee prompted the policy makers to take stringent policy actions against gold .Being recognized as a major import and a drag on our current account asset .Duty hikes and quantitative restrictions were imposed. Gold being an unproductive asset derive its value from future appeal. As more and more people flock to buy gold, the confidence on gold as an investment increases. However due above reasons , gold saw a period of stable to lower prices and this convinced investors that gold had seen its peak. The confidence in gold investment being lost, investors started taking a backseat and started looking at other alternatives
Last year, India imported over 847 tons of gold but new restrictions on gold imports may bring down this figure drastically, analysts said. Festival demand has weakened due to higher prices and lower imports but consumer preferences are changing to platinum, diamond jewelry and light weight gold jewellery, India lost its position as the single largest consumer of gold.
Inflation Index and Tax free bonds
To wean away the Indian investors from gold , the Indian policy makers introduced more appealing form of inflation index government bonds, It was claimed that these bonds had better appeal Unlike their original form, these bonds in their new avatar were linked to the CPI index instead of WPI. However liquidity and predictability issues continue to bog them down. Indian Investors preferred certainty and good returns to liquidity and showed inclination towards high coupon tax free bonds instead.
Mutual Fund and Insurance products
In India, life insurance has typically been looked at as an investment plus protection. Thus, in the investment aspect, it is not very different from mutual funds. The biggest flush of investor funds came into these products in the heyday of financial markets during 2007-2008. These are often called SIPs (Systematic Investment Plans), and ULIPs (Unit Linked Insurance Plan). They are structured to invest regular amounts systematically, mostly in the equity market. However, post the 2008 subprime crisis, market crashes, quantitative easing, and some subsequent recovery, these plans were not making much money. In addition, after 2011, when investors were walloped by high inflation, they were itching to cash in when they broke even on these investments. Consequently, in late 2013, as the equity markets inched towards new highs, mutual funds and insurance companies saw heavy redemptions by investors in these schemes. The retail participation in equity linked mutual fund schemes were strongest in 2008, the retail inflows stood at Rs 32,247crores. In comparison to this the last two years have seen an outflow of retail investors. In 2013, the outflow of retail segment from these products was Rs 11162.8 crores.  A part of the money redeemed from these schemes has gone to high coupon and tax free bonds as the investors preferred these, even though they carry liquidity and some credit risk. These instruments had also become more attractive due to the rising interest rates in the economy resorted to by the central bank to keep inflation and depreciation of the currency under check.
Small Saving Schemes
India’s gross savings rate has declined since 2007-08, and stands at around 30.1 per cent of the GDP. Investors have allocated a part of their savings to high coupon and tax free bonds. The other part has flowed into the older favorite, small savings schemes. Many investors are flocking back to small saving schemes as investors on account of increasing number of scams in various chit funds, Investors are looking for safety that these government instruments provide. Instruments such as post office time deposits and National Savings Certificates (NSCs) are again being revisited The post office and monthly saving schemes make up substantial portion These schemes along with fixed deposits are perceived as risk free. Net Inflows this financial year are expected to turn positive to the tune of Rs 1,100 crore. This is a substantial improvement from previous years which saw a net outflow. In 2011-12, for instance, there was a gross negative outflow of Rs 21,800 crore from all small saving schemes. Although the interest rates in these schemes are not attractive, and high inflation actually depresses the real returns ,but these schemes score on account of safety cushion. Instruments such as PPF also have a competitive edge on account of tax free income they offer.
Some insights about the investment behavior and preferences of small and medium financial investors have been touched upon in this article. The financial year has seen falling economic growth rates and high inflation. Both these macroeconomic variables have dented the saving rates. As small investors grapple with erosion of real returns on account of high inflation and low saving rate, they keep shifting their investment preferences in favor of asset that insulates them against high inflation. A shift from equity mutual funds and gold to high coupon and tax free bonds is discernable. If RBI measures to tame inflation and governments commitment towards the path of fiscal prudence hold water bringing forth milder inflation in the coming financial year .The small investors may start showing renewed interest in equity linked investment products.
 The data has been taken from Association of Mutual Funds in India