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Reversal of Fortunes for Stockbroking

14 October, 2009

 …Stockbroking volumes in India have risen sharply in 1HFY10 on the back of strong FII inflows. Looking beyond short term cyclical drivers, we find that brokers are good long term plays on a country’s economic prospects and therefore outperform the stockmarket on a cross-cycle basis. 

Focussing on the bigger picture
Stockbroking volumes have bounced back strongly in 1HFY10 (up ~55% YoY) on the back of FII inflows of $13.7bn into Indian equities in FY10YTD. Whilst 1HFY10 volumes (Rs. 930 bn ADV) are c.30% higher than FY08 volumes (hitherto considered to be the best year in terms of market volumes), the lack of retail participation puts a question mark on the sustainability of market volumes if FII flows dry up.  However, in terms of the longer term investment hypothesis for stockbrokers, we draw comfort from two points:
 
      Retail savings entering the Indian equity market: Our analysis shows that over the next 20 years, as India’s per capita income rises 4x, her savings rate will go from 38% to 45% of GDP. As a result, annual household savings entering the stock market will rise 9x and annual insurance/long-term savings will rise 7x. Stockbrokers are poised for huge gains from this mega trend both as conduits for retail investors to access the market and as distributors of packaged financial products.
 
      Brokerages outperform on a cross-cycle basis: As is well known, brokers are geared plays on stockmarkets. What is less well known is that globally, brokerages have outperformed the broader stockmarket in most of the major markets over 5, 10 and 20 years. This trend can be seen in India as well where the only major listed stockbroker in India since 1999, Kotak, has outperformed the broader index by a CAGR of 45%. Over the last 5 years, an equal weighted average portfolio of Kotak and India Infoline (the only two significant brokers listed 5 years ago) would have outperformed the index by 27% p.a.
 
MARKET VOLUMES HAVE RISEN SHARPLY
 
After the sharp fall in market volumes in FY09 from their peak levels (down 40% between 3QFY08 and 4QFY09), these have bounced back with a vengeance in the first half of FY10. In 1HFY10 average daily volumes (ADV) have been close to Rs. 930 bn (up 55% YOY) compared to Rs. 610 bn in FY09 and Rs. 554 bn in 4QFY09. The major driver of volumes have been FII inflows, which have been to the tune of $13.7bn YTD FY10 (vs outflows of $10 bn in FY09).
 
However, this rally is still driven by FIIs as retail investors are yet to participate in the rally in a significant manner, either directly or through mutual funds. The share of retail volumes in total market volumes is still low at 53% compared to ~63% in FY08. Moreover, the net inflows to the equity mutual funds have not still picked up in FY10 despite a spectacular rally in the stock market over last six months. FY10YTD net inflows in equity mutual funds are only ~$1.2bn
compared to net inflows of $ 5.6bn and $9.4bn in FY07 and FY08 respectively.
 
Whilst the lack of retail participation, directly or through mutual funds, puts a question mark on the sustainability of market volumes in the near term if FII flows dry up, in terms of our longer term hypothesis for stockbrokers, we draw comfort from two points:

Savings entering equity markets: As highlighted in our 22nd September note, over the next twenty years, as India’s per capita income rises four fold, her savings rate will go from 38% to 45% of GDP. As a result, annual household savings entering the stock market will rise nine fold and annual insurance/long-term savings will rise seven fold. Stockbrokers are poised for huge gains from this mega trend.
 
In case anyone thinks that this is mindless extrapolation, it is worth noting that over the past 17 years, India’s savings rate has risen from 23% to 38% and annual flows of retail money into the stockmarket has risen 6X. So all we are banking on is a mild acceleration, based on data from the rich world, of what is already a well established mega trend.
 
Brokerages outperform on a cross-cycle basis: Globally brokerages have outperformed the broader stockmarket in most of the major markets over five, ten and twenty year periods. This trend can be seen in India as well where the only major listed stockbroker in 1999, Kotak, has outperformed the broader index by a CAGR of 42%. Over the last five years, an equal weighted average portfolio of Kotak and India Infoline (the only two significant brokers listed five years ago) would have outperformed index by a CAGR of 27%.
 

 


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Reversal of Fortunes for Stockbroking

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