Indian Financial Investors: Changing Investment Preferences

The beginning of financial year gave first signs of economic slowdown; and investors’ returns have seen a roller coaster ride; and it is worth introspecting on the changing preferences of small investors and attempt to look for patterns and trends driving against the changing macroeconomic backdrop. 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 quantitative 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,  the appeal for gold increased more than ever before. Across the world   investors started turning to gold as  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 quantitative easing, China and emerging markets growth story, had seen a meteoric rise in commodity prices, investors had begun “financialization of commodities”. In India which hitherto had a huge market for jewelry, now started seeing a paradigm change and  consumers began looking  at gold as an investment option. Gold unlike many other asset classes offered unique advantages, namely

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 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 en-cashed 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.

As per the CSO estimates between 2007-08 and 2012-13, investment in valuables –gold and other precious metals, including jewelry increased five-fold from Rs. 53,592 crore to Rs 266,482 crore.

From May 2013, when US Fed suggested the possibility of tapering of quantitative easing, gold became the biggest loser internationally. Indian investors were still protected because of rupee depreciation, and high inflation. However the looming problem of  current account deficit prompted the policy makers to  take stringent policy actions in form of duty hikes and quantitative restrictions. The confidence in gold as an investment avenue being lost, investors started looking at other alternatives.

Last year, as per official estimates India imported over 847 tons of gold but new restrictions may bring down this figure Consumer preferences too are changing to platinum, diamond jewelry and light weight gold jewelry.

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, these are linked to  the CPI 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 funds and Insurance products
In India, life insurance has bought as an investment rather than protection product hence seen not very different from mutual funds. SIPs (Systematic Investment Plans), and ULIPs (Unit Linked Insurance Plan) were very popular before sub-prime crises. Mutual funds too experienced a similar fate. The retail participation in equity linked mutual fund schemes were strongest in 2008, the retail inflows  stood at Rs 32,247crores. In late 2013, the equity markets inched towards new highs, mutual funds and insurance companies saw heavy redemption’s by investors in these schemes.

Small  Saving  Schemes
India’s gross savings rate has declined since 2007-08, and stands at around 30.1 per cent of the GDP. Many investors are flocking back to small saving schemes having burnt their fingers with scams in various chit funds.Net Inflows this financial year are expected to  turn  positive to the tune of Rs 1,100 crore.  Although the interest rates in these schemes are not attractive, and high inflation depresses the real returns , yet these schemes score on account of safety .

Conclusion
The financial year has seen falling economic growth rates and high inflation. 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 discernible. If RBI measures to tame inflation and governments commitment towards the path of fiscal prudence yield results, it will mean milder inflation in the coming financial year only then will the small investors may start showing a renewed interest in equity linked investment products.