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The behavior of retail investors over the next few weeks/months will determine the course of the Indian market. Our analysis shows that returns of retail investors have been far lower than returns of SMID indices—retail investors have invested more funds at higher market levels. Could the ‘breaking’ point of investors be a lot closer than is generally believed?

Retail investors holding the market; their ‘next’ behavior critical

The investment behavior of retail investors over the next few weeks/months would be interesting to see. Their price-agnostic investment behavior (until recently) and continued purchases of stocks directly and indirectly through DIIs (1) had led to overvaluation in the market for the past 9-12 months and (2) prevented a larger and swifter correction in the market. Foreign investors have been aggressive net sellers over the past few months (see Exhibits 1-2) while DIIs have been absorbing the same (see Exhibit 3).

Index returns may be quite misleading to judge returns of retail investors

In our view, the returns of headline indices (large-cap., mid-cap. or small-cap.) may be quite misleading to determine the returns and future investment behavior of retail investors. In fact, they may overstate the actual returns of investors for two reasons—(1) a number of investors have come to the market at higher levels and (2) a lot more money has come ‘into’ the market at higher levels. Taxes and trading costs would further dent the returns of investors. The market could already be on thin ice based on the usual trailing-returns argument for investment by retail investors. 12-month trailing returns have turned weak while 3-month and 6-month returns are negative (see Exhibits 4-6).

‘New’ investors haven’t had a great experience; interesting to see if they stick

We would assume that ‘new’ investors (last 12 months or so) would (1) have ‘low’ risk appetite and understanding of stocks and (2) be nurturing large losses in their portfolios. We note that (1) a decent portion of investors in mutual funds have come into the market in 9MFY25; see Exhibit 7 and (2) a large number of retail investors have become new shareholders in several ‘narrative’ stocks in 9MFY25 when returns have been low or negative; see Exhibit 8.

‘Old’ investors have possibly poured larger sums of money at higher levels

We estimate that ‘old’ investors would have (1) a ‘higher’ weighted-average price of acquisition of stocks given the timing of inflows into the market directly or indirectly through domestic equity mutual funds and (2) a high weighted-average price of acquisition of stocks pertaining to sectoral/thematic funds given that many of these funds raised money through NFOs at the peak of those sectors or themes; see Exhibit 9 for the weighted-average NAV of new schemes. Exhibit 10 gives the breakdown of fund flows into domestic equity mutual funds over the past few years. As can be seen, (1) fund flows in CY2024 are 25% higher than cumulative fund flows of CY2022-23 and (2) sectoral/thematic funds accounted for 40% and 37% of inflows of CY2024 and 6MCY24.

FPI equity outflows at US$21 bn over October 2024-February 2025

FPIs sold US$28 bn from secondary markets over October 2024-February 2025

DIIs inflows at US$33 bn over October 2024-February 2025

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