By Dr. Simarjeet Singh and Dr.
V. P. Singh
Attractive assets command higher prices as people wish to hold them. However, of lateIndia’s Initial Public Offerings (IPOs) market seems to reflect a divergent view. Age-old wisdom of holding on to attractive assets is changing and is concerning. A recent study by Securities and Exchange Board of India (SEBI) found that investors are heavily influenced by behavioral biases and that too a large majority of them. Significantly observed, is the one called "disposition effect," prompting investors to sell their IPO shares quickly, often within days of listing, to capture immediate gains.The study analyzed 144 IPOs listed between April 2021 and December 2023.
Surprisingly, about 54% of IPO shares (by value) were sold within a week of listing while a staggering 70% were sold within a year. This runs contrary to the accepted philosophy of designing the information set for an IPO. The content design is such that it showcases good long-term prospects for the holders of this stock. But investors seem to be chasing short term gains as the study shows 70 per cent of the IPO shares sold within a year.The case becomes even more interesting as one looks at this tendency in light of listing gains of the IPOs.It is found that IPOs delivering strong listing gains saw the shareholders selling their shares quickly as compared to the ones that didn’t have gains. For instance, the IPOs that had more than 20% gain within the first week saw the investors selling 67.6% of their shares by value within just seven days. However, in case of IPOs having negative returns, only 23.3% of shares were sold. This demonstrates a tendency among investors to cash out quickly when in profit, driven by a desire to “lock in” gains and avoid the psychological pain of watching potential profits slip away.
The Disposition Effect:
Selling Winners, Holding Losers
At the heart of this behavior lies the ‘Disposition Effect’, prompting investors to sell their IPO shares quickly, often within days of listing, to capture immediate gains. Behavioral finance specialists warn of the high cost of ‘disposition effect’ as it emanates from emotional decision rather than a rational one. While quick profit lures investors as a shining opportunity, a rational investor knows that all that glitters may not be gold. The disposition effect can often lead to suboptimal investment outcomes. Prioritizing immediate returns often deprives the investors of a substantial long-term gain. Severaltechnology companies’ IPOs witnessed significant volatility but yielded substantial growth over time. However, by selling early, investors missed out on the full potential of these investments.
Tarun Singh, Founder and Managing Director of Highbrow Securities, explains, "Cashing in on listing gains early may seem enticing, but IPO investors risk missing out on long-term wealth creation.
Behavioral Biases and Market
Dynamics
The broader market dynamics create biases. The period in reference shows a surge in IPOs, with nearly 75% of these offerings delivering positive returns. Disposition Effect got amplified in the environment of high optimism about yielding high returns. Hungry for such returns and the fear of missing out (FOMO) on the next IPO prompted the investors to sell the high gains’ shares quickly and apply for the next IPO. One could have sold the shares not performing well and created the liquidity for purchase of the next IPO. Interestingly, nearly half of all demat accounts participating in IPOs during this period were opened after the COVID-19 pandemic, suggesting a surge in less experienced market participants. This kind of investor may be susceptible to behavioral biases such as ‘regret aversion’ and ‘herd mentality’. The psychological comfort of booking profits quickly, especially in a volatile market, can be appealing to this investor. Another interesting outcome of the study is that 63% of the retail IPO investors came from the three large western border states – Rajasthan, Gujarat and Maharashtra. 39 per cent of these came from Gujarat.
Prashanth Tapse, Senior Vice President of Research at Mehta Equities Ltd, notes, "The post-COVID era has seen a massive surge in retail trading, driven by a confluence of high liquidity and relatively high IPO returns. This has cultivated a quick-profit mentality among investors, where they are more focused on short-term gains than on assessing the true long-term potential of the companies, they're investing in."
Policy Interventions: A Shift
in Market Behavior?
Emotional investing is like contributing to a bubble waiting to burst. Significant wealth destruction contracts consumption and causes recession. Dotcom Bubble Burst (2001) and Global Financial Crisis (2008) are testimony to emotional investing. Cognizant of such threats, SEBI and the Reserve Bank of India (RBI) initiated policy changes. The switch from a pro-rata basis to a lottery system for NII (Non-Institutional Investor) share allotment and the cap on IPO funding by non-banking financial companies (NBFCs) are already showing results. Oversubscription rates for IPOs have significantly reduced and a sharp decline in applications from "Big Ticket" NII investors—those applying for more than ₹1 crore has been observed.It is hoped that such interventions continue to bring sanity by dispossessing the investor of the ‘disposition effect’ and bring sustained rational exuberance in the market.
Profiles of the authors:
Dr. Simarjeet Singh: Assistant Professor, Area: Accounting
and Finance, Great Lakes Institute of Management, Gurgaon
Dr. V. P. Singh: Professor and Director – PGDM, Area:
Managerial Economics & Statistics, Great Lakes Institute of Management,
Gurgaon
0 Comments