Tag: retail investor

Why IPOs don’t make you rich

Personal Finance

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With recent Initial Public Offers (IPOs) delivering blockbuster returns, are you beating yourself up for not applying? On the face of it, the absolute return of 80 per cent on the Zomato stock or 109 per cent on the Tatva Chintan Pharma stock within a few days of the IPO may appear a huge missed opportunity.

But if you’ve been regretting this, you can rest easy. Retail investors in India have a rather low probability of bagging allotments in fancied IPOs. The more heavily subscribed an IPO, the less your chances of winning the allotment lottery. More important, winning the allotment lottery doesn’t mean much. Retail investors who do get IPO allotments usually get such low quantities of shares that it hardly makes a difference to their wealth – even if prices were to double on listing.

Allotment lottery

To know why, you need to know SEBI’s rules on the allotment process for retail investors in IPOs. Book-built IPOs in India are required by regulations to reserve quotas for QIBs (qualified institutional buyers), Non-Institutional Investors (NIIs) and retail investors. Individual investors placing bids of upto ₹2 lakh are treated as retail and those with bids above ₹2 lakh are classified as NIIs.

Investors who bid in IPOs are required to put in applications for at least one lot of shares. Allotments too are made based on the minimum lot size, which varies across issuers. In the Zomato IPO, one lot was 195 shares, in Tatva Chintan Pharma it was 13 shares and in GR Infraprojects it was 17 shares.

Until 2012, the rules required companies to allot shares to all bidders in a book-built IPO on a proportionate basis. But in 2012, to democratise allotment for retail investors, SEBI decreed that all retail bidders should be allotted at least one lot, irrespective of their application size.

When IPOs are under-subscribed or feature a small retail over-subscription, issuers are able to allot one lot to all retail bidders. But in heavily over-subscribed IPOs, issuers find that there are not enough shares to allot even one lot to all retail applicants. In such cases, they choose retail investors who will get one lot through a lottery system. When an IPO is highly fancied, retail investors need to win this draw of lots to bag any allotment. Even if they get chosen, they can hope to receive only one lot of shares, irrespective of their application size.

Modest gains

How this works is better understood by taking live examples of the recent IPOs. The Zomato IPO for instance, had reserved 12.27 crore shares for retail investors but received 27 lakh valid retail applications for 83.04 crore shares. This made it impossible for it to allot one lot to all retail investors and allotments were decided based on a lottery.

The basis of allotment document shows that retail bidders were allotted shares in the ratio of 116:469 for smaller application sizes and 23:93 for larger ones. That is, in the lottery only one in every four retail bidders got allotment. In line with the rule, all these winning bidders, whether they bid for just one lot (195 shares) or the maximum of 13 lots (2535 shares) received identical allotments of 195 shares.

In effect, whether you put in an application for ₹14,820 (195*₹76) or ₹1.92 lakh (2535*₹76), you received Zomato shares worth just ₹14,820 (if you were lucky). Therefore, the maximum gain that any retail investor could have pocketed on the Zomato IPO till date is ₹11,310. While this may seem like a nice round sum to make in a weeks’ time, it will not make a significant difference to one’s net worth.

The retail allotment pattern in Tatva Chintan Pharma, an even more heavily over-subscribed IPO (retail bids for 35 times) drives home the point more forcefully. Given that the retail quota here saw a mad scramble, only 4 in every 100 retail bidders were allotted shares (allotment ratios were at 16:365 and 5:114). Irrespective of whether a retail investor put in an application for ₹14,079 (one lot) or ₹1.97 lakh (14 lots), he bagged just 13 shares. Despite the stock more than doubling post listing, at the current price of ₹2270, the maximum gain that any retail investor could have made is ₹15,431.

The NII gambit

If ‘democratic’ allotments in the retail quotas of IPOs prevents you from making big gains, can you beat the system by bidding more than ₹2 lakh in the NII category? This does improve your chances of allotment, but does not guarantee a meaningful number of shares.

Given that NII portions of fancied IPOs also get heavily over-subscribed, investors who put in lower application sizes within NIIs again have to rely on a draw of lots. To bag assured NII allotment, your application size has to be really large.

For instance, to bag assured allotment in the Zomato IPO, the minimum NII bid you had to place was for 7990 shares or ₹6.07 lakh. But even these NIIs received allotment of just 233 shares. To get a meaningful allotment of Zomato shares worth ₹1 lakh, you needed to put in an application of over ₹40 lakh!

This IPO math in fact drives home an important lesson on wealth creation from equities. To make meaningful money, you don’t just need your stock to deliver blockbuster returns, you also need to own a meaningful position in it, in your portfolio. This is indeed why many seasoned investors prefer to skip the IPO allotment scramble and accumulate IPO companies, if they prove good businesses, well after listing.

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Useful tips to avoid falling prey to bank mis-selling

Personal Finance

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In investing, as in life, it is useful to learn from other people’s mistakes. Some retail investors lost big money in Yes Bank’s Additional Tier 1 (AT-1) bonds last year, after Reserve Bank of India decided to write them off as part of a bailout package. But how did safety-seeking depositors in Yes Bank end up owning these risky bonds where the principal could get written off? SEBI’s order in this case offers some learnings on how you can avoid falling victim to mis-selling.

Get it in writing

In their complaints, the 11 investors said that it was the attractive pitches from their bank’s wealth managers that convinced them to buy the bonds. Some were told that AT-1 bonds were ‘super FDs’. Others swallowed the claim that they were ‘safer than Yes Bank FDs and equity shares.’ Some investors even thought they were merely renewing their FDs with the bank at a higher rate.

Given that none of the above statements were true, it is unlikely that the bank’s relationship managers made these claims in writing to the investors. They were simply taken in by verbal sales pitches.

While selling AT-1 bonds, bank managers were mandatorily required to share two documents with investors – an information memorandum and a term sheet. Asked by SEBI why they didn’t do so in this case, they either claimed that they did, or argued that investors ought to have checked these documents for themselves from the BSE website where they are posted.

Most of us are in the habit of investing in financial products based merely on an application form. The Yes Bank case shows just how injurious this can be to our wealth. Today, no financial product can be sold to you without a formal offer document, information memorandum, term sheet or prospectus. If you’re given only an application form, don’t hesitate to ask for and get hold of these additional documents.

The depositor isn’t king

SEBI’s findings show that of the 1,346 individuals who invested in the AT-1 bonds through Yes Bank, 1,311 (97 per cent) were Yes Bank’s own customers. Of these 1,311 customers, 277 prematurely broke their FDs to invest. Going by the amounts of ₹5 lakh to ₹80 lakh that these folks individually invested, wealth managers targeted the bank’s big-ticket depositors to down-sell these bonds.

While you may wonder why a bank’s staff should wean customers away from its own deposit products, this isn’t surprising.

Bank relationship managers in India have a long history of pitching all kinds of risky products to their customers from ULIPs to balanced equity funds to NCDs as fixed deposit substitutes. While they don’t receive any direct commission from such sales, their compensation packages are often linked to how much fee income they generate for the bank from selling exotic products.

So, the next time your bank’s relationship manager sounds as if he or she is doing you a favour by asking you to switch money out of your FD into an exciting new ‘opportunity’, be sceptical.

High returns equal high risk

Investors who are super-careful about avoiding capital losses in equities often turn far less vigilant when it comes to fixed income. The moment a wealth manager or distributor mentions a higher interest rate product, they’re quite eager to switch to make the switch. But the correlation between high returns and capital losses is actually higher with debt instruments than it is with stocks.

In fixed income, if a borrower is willing to offer you a huge rate premium over safe instruments, it is usually a warning sign that they are more likely to delay or default on repayments. Yes Bank’s AT-1 bond investors should have questioned why the same issuer (Yes Bank) should offer its bond investors much higher interest than it does its depositors. The answer quite simply is that AT-1 bonds can skip their interest payouts completely or write off principal, if the bank’s financials are stressed.

An argument that wealth managers used to sell AT-1 bonds to individuals was that they were sound investments, as they were already owned by institutions. This is a poor argument, as risk appetite and return expectation of a retail investor is seldom the same as that of an institutional investor. Institutions that held those bonds probably invested a minuscule portion of their portfolios while HNIs took concentrated exposures.

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Should you go for pre-IPO investing?

Personal Finance

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With IPO subscriptions going through the roof and the pricing in IPOs expensive in many cases, investors have an option to participate early by investing in companies through the pre-IPO market or the unlisted market. This market, in which HNIs and even retail investors have started investing, helps invest in companies that are unlisted and are expected to go for an IPO in the mid to long term.

According to Unlisted Zone (amongst top 10 unlisted share brokers), their gross transaction value in the unlisted market has gone up from ₹2.1 crore in 2018-19 to ₹19.1 crore in 2019-20. In FY21 (so far), it has been more than ₹40 crore. Also, the number of transactions earlier were 5-10 per day compared to 20 per day now.

How it works

A typical deal in the unlisted market starts with a buyer (with a demat account) getting connected to an unlisted shares dealer. The price and brokerage is agreed upon. The buyer sends money to the seller after which the share transfer is done along with a transaction proof exchange. By T+0 evening or T+1 morning, the transaction is completed with unlisted shares reflecting as ISIN numbers in the demat account of the buyer.

There are no set rules on what is the minimum and maximum investment limit under the pre-IPO investing. It usually depends on the broker you are interacting with. Earlier, the minimum size for pre-IPO deals used to be a few lakh of rupees. But with the ecosystem gaining more depth, i.e., more brokers, more buyers, more ESOP sellers, more research and start-up investing gaining traction, one can start transacting with as little as ₹25,000.

The benefit of a pre-IPO deal is that you buy the companies at an earlier stage and at a cheaper valuation, if available, compared to buying as a normal investor at the IPO. If you can identify opportunities before the market at large does, it can translate to much greater gain when the company goes for an IPO and lists its shares.

Beware the risks

Pre-IPO investing certainly does look interesting but before pushing the pedal on this instrument, understand that it involves high risk.

First, the pre-IPO market is illiquid. You may not be able to sell your shares when you want as there may not be any buyer in the market. The liquidity is low because it is a niche segment that trades over the counter and not through an exchange.

Second, the risk of IPO timeline. The IPO of the unlisted company you invested in can get delayed due to market conditions. Also, it is better to check if the management has provided any guidance on their IPO plans.

Next is the valuation at which the unlisted shares are being bought. Unless, a comprehensive valuation check with listed peers is done, you may end up buying at high valuations.

Further, there is the risk of being charged higher transaction costs by the broker you are dealing with. Investors should note that they can pay maximum 1-2 per cent premium on the cost price as brokerage. So, check prices with a few other dealers and compare before you enter a transaction.

Note that pre-IPO investing comes with a one year lock-in once the company’s shares get listed. So, one may miss the listing gains if the company makes a successful debut on the markets.

Also, if the fundamentals of the company changes and that warrants selling the stock, you may not be able to do so until one year.

Finally, one has to be cautious of frauds. Last year, a Bangalore-based prominent wealth management firm’s founder was arrested for a pre-IPO investing fraud. They took the money for the shares but never delivered the shares. Always deal with a trusted broker with a good track record.

Note that since there is no ombudsman or appointed entity for redressal, the only legal option left is to file a police complaint against the individual or directors of the company.

Taking into consideration all of the above, it becomes apparent that only investors with mid to high risk appetite should take a look at this instrument.

The writer is COO at JST Investments

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