When the stock market booms, brokers make money hand over fist. That’s easy to comprehend, and a well-accepted fact. More people wanting a slice of the action spells more trading activity, more money allocated means more client funds put to work, and higher valuations mean more rupees earned per trade.
Naturally, there is a high correlation between stock prices of broking firms and benchmark indices. We looked at the stock prices of ICICI Securities, 5 Paisa and Motilal Oswal Financial Services and their correlation with the BSE Sensex and BSE-500 indices. The results were interesting. ICICI Securities has had the highest correlation of 0.97 with the BSE-500 and 0.95 with the Sensex. The same numbers for 5 Paisa were 0.78 and 0.56, and for MOFS 0.53 and 0.46. This suggests that the ICICI Securities stock is the most correlated to market movements, and perhaps a better play if you are looking to track market gains.
What’s more, broking firms with strong digital platforms are better placed to tap the new business, given the ease of access especially in COVID times. This is reflected in their growing share of the pie, with the top 5 digital brokerages accounting for 73 percent of new NSE client additions in FY21, according to data collated by Angel Broking.
Market intermediaries track swings
Not just brokers, even market ecosystem entities like stock exchanges and depositories have their fortunes closely tied to the markets. The high correlation of demat accounts to the BSE-500 at 0.96 is evidence enough.
That’s because booming markets spell more entrants into the market and therefore more demat accounts. The IPO rush we are witnessing now is also a typical bull market phenomena. And many first time investors tend to the enter the market via the primary route, so a Gen Z appeal of the Zomato IPO leading to the entry of several first time youngsters isn’t a far-fetched idea.
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For players like Central Depository Services Limited (CDSL), that derive a bulk of their incomes from annual fees from issuers and from transaction charges, a buoyant market is great news.
ASSET MANAGERS RIDE GAINS
The other big beneficiaries of a trending stock market are asset managers like mutual funds. While in terms of their assets under management (AUM) the equity-debt ratio for mutual funds stands at 43:57, the income earned by them on actively managed equity schemes is higher. As a result, their fortunes are strongly correlated to the markets. Besides, debt doesn’t see the kind of valuation change that equity sees in bull runs—and this lifts the assets under management irrespective of how the inflows trend. A study of mutual fund AUMs and the BSE-500 reveals a high correlation of 0.98.
Typically, mutual funds earn a percentage of AUM as income, and for the top few, the annual rate is around 0.5 percent. This can see some variation with share of equity in the AUM—higher if equity is higher—and if more money is invested by people in smaller towns (B category locations, as per mutual fund norms), but the trend generally tracks market moves.
It’s all about the market
It is therefore clear, that a bet on market intermediaries is a bet on the market trend. And while factors cited like levels of financial inclusion and penetration are good long-term potential indicators, some of the global comparisons need to be taken with a pinch of salt.
One number often cited is the demat penetration. India’s demat account penetration stands at 4.1% compared to over 11% in China and over 32% in the US. However, dive deeper and you’ll find that the income distribution in India and the actual level of income and savings in India are also at a high variance with these nations. So, yes, penetration may increase as we grow, but don’t expect to match those in other countries until we can attain similar purchasing power parity. And that seems some way off.
Besides, even this economic and income growth will likely get captured in the market. So, by betting on these businesses, you are effectively betting on the market trend. That means, if the market turns the other way, given their high correlation, the share prices of these businesses would swing the other way as quickly.
My preference, if I wish to play the market in the short-term, would be through an index fund rather than a market-linked business. Over the longer-term, mutual funds and digitally savvy intermediaries can be an interesting prospect too, but be prepared for volatility.
(Edited by : Santosh Nair)