Fear and Greed are the fundamental emotions that drive market volatility. Investors often oscillate between these extremes, leading to impulsive decisions, Ananth Narayan Gopalakrishnan, whole-time member, Sebi, said at Outlook Money’s 40After40 Retirement Expo in Mumbai.
He covered critical aspects of capital formation, regulatory challenges, technological disruptions, and common behavioural pitfalls among investors in his speech.
Read more: https://www.outlookmoney.com/retirement/forty-after-forty
#OutlookMoney40after40
He covered critical aspects of capital formation, regulatory challenges, technological disruptions, and common behavioural pitfalls among investors in his speech.
Read more: https://www.outlookmoney.com/retirement/forty-after-forty
#OutlookMoney40after40
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LearningTranscript
00:00Good afternoon, ladies and gentlemen.
00:08Thank you, Outlook, for giving me this opportunity to address you all.
00:12I have to compliment Outlook.
00:14The fact that you're doing so much, which is actually our job in Western Awareness and
00:19Education, I have to compliment you for this and I hope more people join the tribe in spreading
00:24the good word around on responsible investing.
00:28Now, my own session here, frankly, is like a palate cleanser between good sessions.
00:36I'm sure you would have liked Davina to continue with her pearls of wisdom and listen to that
00:40than having to listen to a boring regulator.
00:43But we are a part of the ecosystem and maybe there are a few messages that I can pass on
00:48as well.
00:49Now, the topic is pretty interesting.
00:52Can regulation counter behavioral errors?
00:57It's a bit like asking, is your doctor responsible for your health?
01:02I know it's a poor analogy.
01:04We are not doctors as SEBI and neither are investors, patients.
01:09But there is an extension of that.
01:12A doctor typically comes in when things are bad.
01:16He's not necessarily responsible for the state of you coming there.
01:21And it's important that a lot of other things, including we as individuals taking ownership
01:27of our health, precede our good health.
01:34The other reason why I like this analogy, even though it's not a perfect analogy, in
01:39this Hippocratic oath that doctors take in serving patients, there is a very nice crucial
01:45line, which is first, do no harm.
01:52With the best of intent, with the intent to improve somebody's health, doctors can do
01:58things where the cure is worse than the disease itself and give you lots of after effects,
02:05lots of other consequences, which was never intended in the first place.
02:11Regulators role is very, very similar.
02:15Our job as SEBI is to ensure that there is sustained capital formation in the economy.
02:23And I've often said this and my friends in the media will have tired of me saying this.
02:30Our job, therefore, is not just to be a regulator coming and pulling up people who do things
02:35wrong.
02:37It is to ensure sustained capital formation.
02:40And there are two types of errors that we as regulators can commit.
02:46The first type one error is when we let bad things happen.
02:51So when a Harshad Mehta happens, when a Ketan Parekh happens, then we as a regulator take
02:57flack for this type one error.
02:59What were you doing?
03:00Ye sabko pata tha, aap so re the kya?
03:03And we as regulators are terrified of what the next type one error could be.
03:10So we're always guarding against that.
03:12However, there is a lesser known and lesser spoken of error, which is a type two error,
03:19where in our zeal to prevent type one errors, we come with so much of regulation, we come
03:26with so much of stipulations, that even good people stop doing business.
03:33That is a type two error, and we have to be equally guarded against type two errors
03:38as well.
03:40For capital formation, it's important that we minimize both these type one and type two
03:45errors.
03:47The easiest way to stop type one errors would be to close all markets.
03:51But that would not do well for capital formation.
03:55There is a third thing that we have to worry about, which is, we are in the cusp of the
04:01nature of capital markets changing dramatically going forward.
04:06And I know these words are often spoken loosely.
04:09But the reality is with things like artificial intelligence, with things like quantum computing,
04:16and with things like what is possible in robotics, over the next 5, 10, 15, 20 years, I don't
04:22know what the timeframe is, over these years, the nature of our economics is going to change.
04:29People often say we overestimate change in the short run, and we underestimate change
04:33in the long run.
04:35I think we are in the midst of a massive change, a massive change in the nature of our business.
04:42Imagine if things are getting what we consume, goods and services, if they are being produced
04:47practically for free in a new world, what will be the nature of capital?
04:53What will be the nature of our capital markets ecosystem?
04:56Much of it is unimaginable.
04:58Why I am mentioning this is, as we try and understand what this new, brave new world
05:06is going to look like, and I think many of the young people here will define that world
05:09over the next 5, 10, 15 years, we have to make sure that we invent the future, rather
05:16than be reacting to it.
05:19I can assure you, in 10 years' time, the nature of capital markets will be different.
05:25Which means we have to take risks today, to make sure we are part of the system that's
05:30creating the future, rather than reacting to it.
05:34And again, as a capital markets regulator, along with the ecosystem, we have to ensure
05:40we are conducive to that.
05:41Now, let's come back to behavioural errors.
05:45There are plenty of behavioural errors that all of us, as individual investors, as people
05:50who see investors around us, are aware of.
05:54The first quintessential behavioural error is fear and greed, and everything in between.
06:00That's what drives all markets.
06:04Another error, which I've spoken about earlier, is the error of overconfidence and over-trading.
06:10There is plenty of research, including one seminal one which I liked by Barber and Odeon,
06:16which shows that the more you trade, the less you make in the normal situation.
06:22I'm talking about normal human beings, I'm not talking about the Warren Buffets, which
06:25are the exceptions of the world.
06:29And this fundamental premise, that over-trading is not good for your investment health, is
06:35something we all tend to forget.
06:37Third, we tend to not focus enough on asset allocation.
06:43We worry more about stock picking, timing the markets, listening to the next tip, and
06:48so on and so forth, where plenty of research shows again and again and again, that these
06:55things, stock picking, timing the markets, account for a minuscule proportion of the
07:02difference in returns across portfolios.
07:05Bulk of the return of your investment portfolio is decided by your asset allocation.
07:11And normal investors tend to spend the least amount of time on that, and the most amount
07:17of time on timing the market or trying to see which stock to buy and which stock not
07:20to buy.
07:22Fourth, the fact that we are fin-fluenced, that we look for tips, that we are waiting
07:30for mana from heaven to come from the sadhus of the world or the investment world, who
07:35will tell us what to do.
07:39There is this old saying that, you know, all roads lead to Rome, all roads lead to capital
07:44market appreciation, but be careful who takes you there.
07:49And that fear of missing out sometimes misguides us.
07:51Fifth, we have herd mentalities.
07:55And I'm going to give you some numbers from our own ecosystem.
08:01Between FY22 and FY24, the actual inflow coming into our mutual funds' risk-oriented schemes,
08:09which is equity funds, balanced funds, ETFs, index funds, etc., averaged about 3.2 lakh
08:16crores per year.
08:19That was a fresh amount of money coming into the ecosystem.
08:21That's not bad.
08:22We need money coming into the capital market's ecosystem.
08:26But the reality is, the amount of fresh capital being raised by way of equity issuances, etc.,
08:33during that period, hardly averaged about 1.5 lakh crores per year.
08:40So during that period, and I'm only counting mutual fund inflows, I'm not counting FPI
08:44inflows, I'm not counting other DII, you know, insurance company pension fund inflows, etc.
08:50So the amount of money that was flowing into capital markets was far higher than the amount
08:55of supply of paper or demand for capital coming in from the issuers.
09:02That becomes by itself a formula for possible capital appreciation, rather than actual
09:08capital formation.
09:10This year, by the way, we've had a record amount of fresh IPOs coming through and the
09:15supply of paper suddenly has gone up quite a bit.
09:18Good news, so has the demand for paper.
09:21In fact, this year is far more balanced in terms of this difference between supply and
09:25demand.
09:27Between April and December, fresh money coming into mutual funds has already hit an all-time
09:34record of 4.8 lakh crores.
09:38This is into risk-oriented equity schemes, balanced funds, ETFs, and so on and so forth.
09:45The amount of IPOs until December, and it's only growing even now, from an average of
09:51about 1.4, 1.5, and I'm talking about not necessarily, you know, OFS, etc.
09:57Fresh paper being issued to the market reached a record of 2.9 lakh crores as of December
10:04itself.
10:05So both supply and demand have gone up, and it's important for us to be aware of this.
10:10Are we in the midst of a self-fulfilling prophecy where our money is coming and raising market
10:14prices and making us feel good, or is it a much more balanced case of both supply and
10:19demand being there and therefore things being a lot more sustainable in the longer run?
10:24So this herd mentality is something that we have to keep in mind as well.
10:27And finally, the bottom line of all of this, the biggest behavioural error is being unaware
10:35of risk, being unaware of our own individual risk appetite, and being unprepared for risk.
10:43We are doing ourselves a disservice by doing this, and we are risking the ecosystem by
10:48doing that.
10:50Ultimately, for capital formation, we need risk-informed, well-informed, eyes-open investors
10:57coming in, bringing in risk money into the ecosystem.
11:01We need good issuers coming in and raising that capital, creating jobs, creating businesses,
11:07which in turn creates more savers, and then this virtuous cycle can continue.
11:12If we come in with glassy-eyed, expecting-to-become-millionaires and billionaires overnight, and listen to
11:18and are not adequately risk-aware, we risk creating a shock where the cycle gets broken.
11:30So what is SEBI's role in all of this, in this behavioural error that we can see?
11:37I have to hasten to add, charity begins at home.
11:41Ultimately, it is each of us as investors who have to take care of our behavioural biases.
11:48The moment we have an external focus of somebody else has to take care of my health, we are
11:53starting off in the wrong place.
11:54Having said that, we will not shirk our responsibility.
11:57I'll tell you a little bit about SEBI's approach towards making sure that these behavioural
12:01errors are addressed.
12:03First, we try and ensure there are adequate disclosures so that investors can make informed
12:11decisions.
12:14We insist, for instance, that companies that are coming out with IPOs and fresh capital
12:18raises have to disclose all their risks in a comprehensive manner and in an intelligible
12:25manner so that people can come in and know what they are getting into.
12:31Any other issuer of security or a seller of a security has to give these disclosures out.
12:37Mutual funds which are offering you schemes have to tell you where they fall on the risk-o-meter,
12:42how risky are they.
12:43It's not a perfect measure, there are better ways of expressing risks, but at least it's
12:47a good start.
12:50However, just asking for disclosure doesn't necessarily mean that we can stop there.
12:59We've got to make sure that the quality of the disclosures is good, there are checks
13:05and balances to ensure that the disclosures are correct and comprehensive, which means
13:11a whole ecosystem of people are involved in this process, not just SEBI, and I'll come
13:16to that in a minute.
13:18Second, we've got to make sure, as part of the disclosures, that investors are aware
13:26of conflict of interest.
13:28For instance, when you deal with a mutual fund distributor, the reality is the mutual
13:34fund distributor gets a commission from the producer, from the mutual fund itself.
13:42This is completely kosher, this is the way distribution works, where distributors get
13:48paid by the producer.
13:50Now, we've got it in the code of conduct, AMFI's got it through the code of conduct,
13:55that distributors have to work in the best interest of the investors.
14:00At the same time, investors should be aware as to whatever is being sold to them, is it
14:07truly in their best interest, or is it to increase somebody's fees?
14:12And again, that disclosure, we want it to be as transparent as possible, without necessarily
14:17coming in the way of legitimate businesses.
14:22I'm going to touch upon a topic which has been topical, which is on over-trading in
14:27futures and options in the derivatives market.
14:31That's an epitome of behavioural errors that has been observed in the market.
14:39Again, our approach as SEBI, in respect of derivatives, has been very clear.
14:45We are not a nanny state which will tell you, the investors, what you can do, what
14:52you can't do.
14:54You are intelligent people, it is your hard-earned money, we are terrible at telling you where
15:00to invest and where not to invest.
15:02However, again in the spirit of disclosure, we want you to be aware of the risks, which
15:08is why we have come out with a series of research papers, initially showing that 89% of individual
15:15traders lose money in F&O, following it up with a more comprehensive study last year,
15:21which showed that over the last three years, 93% of individual traders have lost money
15:27in F&O markets.
15:29Not only that, people who have lost money for two years in a row, 75% of them, continue
15:35to trade in the third year as well.
15:39It's almost a national obsession in many ways, where you know that the house is lowered
15:46against you, and you still want to try your luck.
15:49Again, it's not our job to tell you what to do, what not to do.
15:53And we need derivative markets for price discovery, for depth in markets, for risk management,
15:59all of that.
16:00We are not against derivative markets, but we want investors to be aware of the risks.
16:06Similarly, in a parallel and corollary vein, we have got to make sure that the markets
16:13are safe, they're free from manipulation, that they show risks adequately, and investors
16:20can get in knowing that they're not being taken for a ride by things like unfair trading
16:24practices.
16:26That is constant work in progress, and you will soon see some consultation papers coming
16:32out from SEBI on strengthening the risk in the ecosystem, and risk measures and risk
16:38management of the ecosystem, purely to ensure that the risk and the perception of risk around
16:46things like manipulation and unfair trading practices can be reduced in this market.
16:51Finally, I want to talk about the ecosystem which ensures that this disclosure happens
16:59appropriately.
17:00First is the management and the business itself.
17:03The primary responsibility for disclosures is always the management, whether it's mutual
17:08fund management, the issuer corporate management, whether it's the mutual fund distributions
17:13management, every intermediary, every counterparty in this ecosystem has a responsibility at
17:19the primary business level.
17:22Then you have checks and balances like the governance systems, the board of the company,
17:27they're charged with ensuring that risks are adequately disclosed, and that disclosures
17:33and the numbers that come out are true and fair, and so on and so forth.
17:39Companies are required to have independent risk chains, as are most institutions that
17:43are part of a capital markets ecosystem.
17:46Things like rating agencies, which we regulate, are there to ensure that there is an adequate
17:53independent check and balance, and we as a regulator do not opine on the ratings.
17:58We don't know the ratings, but we try and make sure that any possible conflict of interest
18:04is addressed, and that rating agencies can do their job freely and fairly and professionally,
18:11and that they're held accountable to some extent for whatever they come out with.
18:17There are agencies like auditors, there are market infrastructure institutions, the exchanges,
18:23the clearing corporations, the depositories, which are first-line regulators.
18:28There are research analysts, professional investors, financial institutions, the media,
18:34and each one of us as responsible investors.
18:36We are all part of this ecosystem to ensure that there is truth in the ecosystem, that
18:42we all have collective trust in it, and that therefore, people can take their risk, their
18:50investments in an informed, responsible manner.
18:54Again, I'm not shirking our responsibility as SEBI.
18:58Of course, we have a crucial role to play.
19:00My simple pitch to you is, things like behavioral errors are too critical and crucial to be
19:08left to the doctor or to SEBI alone.
19:12It is a collective responsibility, starting from the investor herself, flowing up the
19:17chain of every intermediary and every governance mechanism in the ecosystem, and finally, of
19:23course, landing up as SEBI.
19:26I have this thing which I've said in the past before.
19:31It's not a great idea to rely on SEBI for things like ensuring everything is good in
19:36the ecosystem, because SEBI is a bit like the old Bollywood movie police guys who arrive
19:44at the scene after the climax, after the hero has bashed up the villain, and then we come
19:48firing in the air and say, you know, now this is the end of the movie.
19:53So if you're waiting for the Bollywood policeman to come, you're not in a good place.
20:00You need a lot of the checks and balances in between to work to be able to address this
20:06in a timely and proactive fashion.
20:09Having said that, once again, thank you so much to Outlook Money for doing this.
20:13We need to have more of these informed debates.
20:16And here's to more sustained capital formation.
20:19We're all in this together to ensure that savers come in with their eyes open, bring
20:23in this capital, and that issuers raise this capital to create more jobs, more businesses,
20:29so that we go into this lovely cycle of sustained capital formation and economic growth, and
20:35we achieve our immense economic potential.
20:37Thank you so much once again.