Asia's oldest stock exchange finds tough love from investors

The Bombay Stock Exchange, Asia's oldest stock exchange founded in 1875, saw dismal participation from investors on the first day of its IPO. Barring retail participation, the issue saw negligible bids coming in from Corporates and no participation from FIIs, DFIs or Mutual Funds. This speaks volumes about the issue quality. Coming shortly within the demonetization exercise, the issue should have seen better participation atleast from the domestic players. However, apart from a measly 1,000 odd shares none of the domestic or foreign players found the issue alluring. 

There are still good chances that the issue may witness last-minute participation from “motivated players” and get filled up as happened with other downbeat issues. However, investors looking to hold the stock over the long term need to be tread very carefully. “Motivated players” interested in the issue due to extraneous reasons can get demotivated very easily and jump to other issues.

Natural gas fires up MGL and IGL

Natural Gas has emerged as the best performing financial asset of 2016. This has provided a huge impetus to companies such as Mahanagar Gas Limited (MGL) and Indraprastha Gas Limited (IGL), both returning 65% and 54% respectively since July 2016.

Source: Yahoo Finance

However, just because an asset/ sector has outperformed in a particular year is no reason why it will continue the winning streak. For instance, energy was the best performing sector in 2007 only to crash 39% the very next year. Also lower valuations for the under-performing asset class will see renewed fund inflows. In 2015 the energy sector was the worst performing sector only to emerge as the best performing in 2016.  It has led the pack after a gap of almost 9 years.

Excepting a few outlier years, sector returns almost resemble a W with outperformance in one or several years and then subsequent downturn only to head back up again.

As Benjamin Graham mentions in Security Analysis, "There are several reasons why we cannot be sure that a trend of profits shown in the past will continue in the future. In the broad economic sense, there is the law of diminishing returns and of increasing competition which must finally flatten out any sharply upward curve of growth. There is also the flow and ebb of the business cycle, from which the particular danger arises that the earnings curve will look most impressive on the very eve of a serious setback."

Further as Warren Buffet mentions, "We are quite content to hold any security indefinitely, so long as the prospective return on equity capital of the underlying business is satisfactory, management is competent and honest, and the market does not overvalue the business." In other words, when the security has moved ahead of itself in a very short time it may be time to sell the security. 

Investing in MGL at these levels could be a bit expensive given the 65% return in about 6 months.

Why FIIs can spoil NSE's party

National Stock Exchange of India (NSE) is planning to list its shares on the stock exchanges and has filed a DRHP with SEBI. It is the leading stock exchange in India and has 85% share in Equity cash trading and 94% in Equity derivatives trading. The nearest competitor, BSE, is miles away in terms of technology and trading volumes.

FIIs constitute a 20.9% client base in the Cash market segment and 14.4% client base in the Equity Derivatives segment. As is well known, FII investment can be quite fickle and can change their temperament in a very short period of time. Since Oct 2016, FIIs have been net sellers in the Indian market and have sold off equities and bonds totaling Rs. 76,673 crores. This is almost 6 times the amount sold off in Oct 08 - Dec 08, the height of the financial crisis. There may be several reasons for the FIIs exit, whether it be the Trump factor and subsequent US market jump or India's demonetization drive.

A key difference between the two periods is that in the 2008 period, FIIs were net buyers in the debt
market. However, in the current period they have turned negative on both equity and debt segments.

Trading income drives almost 63% of NSE's revenues. With a bearish FII sentiment towards India, this may come under pressure.

Apart from the recent SEBI probe and corporate governance issues, another aspect to consider would be the returns delivered by major listed exchanges over the past year and their valuations. Of the major exchanges, only LSE delivered positive returns of 6.20% over the past year. The P/Es ranged from 20.6 for the Deutsche bourse to 42.73 for LSE. For a comparative analysis, LSE had revenues of £1.41 bn for the year ended 31.12.2015, whereas NSE had revenues of £281 million for the year ended 31.03.2016.

Although there is not much domestic competition for NSE, what would really matter is the foreign appetite for Indian securities.