India’s stock market rally looks like a self-sustaining Ponzi scheme

In comparison, this figure was at 33.5% in June 2021. Floating stocks are shares that are available for buying and selling on stock exchanges, after leaving out shares owned by promoters and others who hold them closely.

The actual retail ownership is higher than 38% because insurance companies also invest the premiums they collect through unit-linked insurance plans (Ulips) in stocks. And investors in Ulips are primarily individuals. The NSE does not provide a separate figure for this and the insurance ownership is bundled along with that of banks and financial institutions. 

This ownership has gone up from 10% as of June 2021 to 11.4% of total floating equity as of March 2024. Hence, it’s safe to say that retail ownership is now more than 40% of NSE’s floating stock.

So, how did this happen? There has been a massive increase in money flowing through systematic investment plans (SIPS) into equity MFs. SIPs are a way of investing regularly in MFs. It is estimated that 90% of the money invested through SIPs is invested in MFs that primarily invest in stocks. 

In 2016-17, the total amount of money that was invested in MFs through the SIP route was ₹43,921 crore. It shot up to ₹96,080 crore in 2020-21 and to ₹199,219 crore in 2023-24. From April to June 2024, a total of ₹62,537 crore has been invested into MFs through SIPs. The bulk went into stocks.

Further, the Employees’ Provident Fund Organisation (EPFO) also invests a portion of the money that it collects in exchange traded funds (ETFs), which in turn buy stocks. In December 2023, the government said that in 2022-23 the EPFO had invested ₹53,081 crore in ETFs, which are basically index funds listed on the stock exchange. 

Index funds are expected to buy stocks which make up a particular index, let’s say the Nifty 50, in the same proportion as the weightage of stocks in that index. 

The EPFO’s increasing ownership of stocks shows up in the form of ETFs owning more stocks, which shows up in increasing ownership of stocks by domestic MFs. All this buying has led to the ownership of domestic MFs increasing from 14.6% of floating stock in June 2021 to 18.4% in March 2024.

Over and above this, more individual investors have been buying stocks directly, with the individual ownership of floating stocks going from 18.9% in June 2021 to 19.6% in March 2024.

Factors ranging from the cheap availability of smartphones and internet data to low-interest rates in covid years and the work-from-home phenomenon have led to increasing retail interest in stocks. But that’s the old story.

The stock market has now degenerated into what the Nobel Prize winning economist Robert Shiller refers to as a “naturally occurring” Ponzi scheme. A Ponzi pyramid is a fraudulent investment scheme where older investors are paid by using money brought in by newer ones, and so long as the money being brought in by new investors is higher than the money that needs to be paid out to older ones, the fraud runs.

In case of a ‘naturally occurring’ Ponzi scheme, there is no fraud committed by a schemer; nonetheless, the structure is similar to that of a Ponzi scheme. As Shiller writes in Irrational Exuberance: “Naturally-occurring Ponzi schemes do arise… without the contrivance of a fraudulent manager… Investors, their confidence and expectations buoyed by past price increases, bid up speculative prices further, thereby enticing more investors to do the same, so that the cycle repeats again and again.”

Basically, the sharp rise in Indian stock prices is currently the strongest attraction for new retail investors. As Shiller writes: “When prices go up a number of times, investors are rewarded sequentially by price movements in these markets, just as they are in Ponzi schemes. 

There are still many people (indeed, the stock brokerage and mutual fund industries as a whole) who benefit from telling stories that suggest that the market will go up further.”

So, the market is going up because the market is going up. And like in a Ponzi scheme, as long as more money keeps coming in than gets taken out, stock prices can keep going up. 

As Joel Tillinghast writes in Big Money Thinks Small: “As long as the fund is receiving inflows… [fund] managers can use the new cash to further pump the stock price. Or they can let the inflows reduce the portion of the fund held in inflated stocks.” And that’s precisely what is happening in Indian stock markets right now.

Retail investors (individual investors plus domestic MFs plus Ulips) now hold more than 40% of the floating stock of companies listed on the NSE. Foreign institutional investors hold 36.8%. 

And as long as retail money keeps coming in, it will be pointless talking about how stock prices and thus their valuations are not justified by their prospective earnings. Under the prevailing conditions, the market will continue to go up because it has been going up.