Lessons from the 2007 financial market crisis

As curtains came down on the year 2017, the markets have given investors much to celebrate since the dark hours of the financial crisis of 2007. It is important to look at the crisis as a catalyst that helped us learn and transform over the years. Here are some of the learnings from the crisis.

Learnings from economy/policy viewpoint: First, notwithstanding the soundness of domestic economic policies, a country can get impacted due to crisis in other countries given the inter-linkages in the global economy. Second, fiscal consolidation is important in good times to create room for fiscal cushion for counter cyclical policy responses during a crisis. Third, the leverage of financial institutions has to be under control to prevent a domino effect on the entire financial ecosystem. Fourth, learning from financial/economic history is important to prevent and deal with future crisis. 

Learnings from an equity investor’s perspective: Stick with an asset allocation plan and do not get swayed by prevalent fad. Overexposure to any asset class, while tempting, ends with bad results. Another important learning is the importance of sticking to fundamentals for long-term investment success. The crisis also taught us the importance of discipline when it comes to leveraged investments. The fourth lesson is that exuberance-driven investments in ultra-expensive stocks/sectors based on hope/fantasy can never substitute solid research-driven investments in stocks with underlying value greater than the price.

Look at the changes that have come about after the financial crisis. The Indian markets have seen proactive regulatory changes, including the Companies Act 2013, Ind-AS and the Insolvency and Bankruptcy Code. These reforms will continue to strengthen the regulatory and governance framework. The Securities and Exchange Board of India (Sebi) has been ringing in numerous reforms— the commodity derivatives segment is an example of this.

Technology has emerged as an important factor shaping the business landscape and investments in this area have taken a big leap. All meaningful brokers in the industry have invested significant sums to upgrade their technology platforms. The counterpart mutual funds or FIIs or foreign banks have started using DMA and ALGOs in a big way. It is estimated that approximately 35 per cent of their business flows are through the DMA while almost 90 per cent comes through various technology connectivity tools.

The growing adoption of online and mobile phones by consumers for banking, payments and shopping has prompted the financial/broking industry to offer a range of online/mobile services. According to the National Stock Exchange, more than 50 per cent of its turnover is derived from online sources.

Diversification is key in today’s complex financial scenario. In line with that, we have seen the growing role of mutual funds in the Indian investment landscape. Inflows in domestic mutual funds have been massive — $36.3 bn over 2015-17 — with the highest-ever annual inflow of $18 bn in 2017. Over the same period, FII inflows in equities stood at $13.4 bn, less than half of mutual fund inflows. SIP has seen its contribution increasing — from Rs 38.8 billion in November 2016 to Rs 59 billion in November 2017. Reforms like demonetisation have provided a big thrust to ‘financialisation of savings’ in India, with rising mutual fund inflows being one of the outcomes. Consequently, equity Assets Under Management (AUM) of mutual funds has almost doubled from Rs 3.2 trillion in 2014 to Rs 7.3 trillion in December 2017. The total AUM of the Indian mutual fund industry at Rs 22.8 trillion is at an all-time high (versus Rs 11.8 trillion in January 2015). Over the last five years, several foreign asset management companies (AMC) have exited India after selling their stakes to Indian AMCs.

Stocks markets have also benefited from the increasing acceptance of equities by the Employee Provident Fund Organisation (EPFO). The EPFO started investing in equities in August 2015, and now 15 per cent of PF contribution is invested in exchange-traded funds. It invested 5 per cent of the annual incremental corpus (Rs 66 billion) in equities in FY16, which increased to 10 per cent (Rs 150 billion) in FY17.

Other vehicles of investments like Portfolio Management Services (PMS) and Alternate Investment Funds (AIF) too have come into vogue. The number of clients and AUM of PMS have gone up steadily. AIFs are seeing solid growth in commitments — the total investment received jumped about 4x to Rs 435 billion in September 2017 from Rs 113 billion in September 2015. The evolution of REITs has been one of the key highlights of recent times.

One of the biggest developments in the Banking, Financial services and Insurance space is the listing of many insurance players, asset management companies, brokers, small finance banks and exchanges. This is in addition to the spectacular growth in Non-Banking Financial Company in the past five years. 

Asset reconstruction companies (ARCs) have been a buzzword lately. However, the size of ARCs is still  modest and we need more and larger players in the distressed asset space to help lenders in tackling bad debt.

The evolution of the start-up ecosystem accelerated in India over the last three years, bolstered by strong funding and a benign interest rate scenario in the world. Even private equity players have seen good growth: 2016 and 2017 have seen multiple profitable exits by private equity firms via IPOs. Fresh investments have continued — PE firms invested $11.3 bn in India in the first half of 2017, a record-high.

As the Indian economy formalises with the government’s structural reforms and as financialisation of savings continue, the market ecosystem is poised to see exciting times. Clearly, the lessons of the financial crisis are well learnt and, more importantly, applied.

The author is CMD, Motilal Oswal Financial Services Ltd

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