STRUCTURING THE EQUITY GAP
What is equity gap?
If it can be put simplistically, then equity gap is the difference between the investors' appetite and the company's requirement of funds. Company usually use this door of raising funds via equity but is the investors' appetite towards investing in equity enough.
Based on an analysis by Mckinsey Quarterly the financial assets in the world are worth 198 trillion dollars. Out of which around 21 percent are part of emerging markets and the rest is a part of developed economies. This tells that around 157 trillion lies with the developed world. Among these financial assets, the household investment in equity is decreasing. Among the households portfolio, in emerging markets the proportion is around 15 percent while the household portfolio in developed countries like U.S has 42 percent contribution towards equity. The contribution towards equity is decreasing. Even the developed countries are also showing less appetite for equities. Among developed nations, Japan stands out for its very low investment in equities. Despite a long tradition of equity investing by individual investors for most of the 20th century, Japanese households now hold less than 10 percent of their assets in equities, down from 30 percent before the 1989-90 crash. Because of low or negative returns over the past two decades, Japanese allocations have never exceeded 18 percent in this period.
The facts tells us the proportion of investments in various countries. We can see that among the financial assets, the majority of these assets are in household portfolios. Among the 198 trillion financial assets 85.2 trillion are in household portfolios. This makes it to around 50%. If the household appetite for investments in equity decreases then it shows the overall picture of investments. It is approximated that the global financial assets would reach the 371 trillion by 2020. Of these assets the contribution of emerging market would increase from 21 percent to 36 percent while the developing countries would come to around 64 percent. Emerging market financial assets grew 16.6 percent annually over the past decade, nearly four times the rate in mature economies. These assets stood at about $41 trillion in 2010 and constituted 21 percent of the global total, up from 7 percent in 2000. Depending on economic scenarios, we project that emerging market financial assets will grow to between 30 and 36 percent of the global total in 2020, or $114 to $141 trillion Of these financial assets the contribution to equities which was around 28 percent in 2010 would come down to 22 percent by 2020.
Some of the reasons for decreasing attitude towards equity can be:
• Ageing population in western world
Aging is the largest factor affecting investor behavior in mature economies. As investors enter retirement, they typically stop accumulating assets and begin to rely on investment income; they shift assets from equities to bank deposits and fixed-income instruments. This pattern has led to predictions of an equity sell-off as the enormous baby boom generation in the United States and Europe enters retirement9 (the oldest members of this cohort reached 65 in 2011). This effect can be staggering: if investors retiring in the next ten years maintain the equity allocations of today's retirees, equities will fall from 42 percent of US household portfolios to 40 percent in 2020--and to 38 percent by 2030. In Europe, where aging is even more pronounced, we see an even larger shift in household portfolios.
• Shifts to defined contribution retirement plans: Also influencing equity allocations in mature economies are the shift to defined contribution retirement plans in Europe and rising allocations to alternative investments. In Europe, it can be seen that defined-contribution plan account owners allocate significantly less to equities than managers of defined-benefit plans. And as private pension funds close to new contributors, managers are shifting to fixed-income instruments to meet remaining liabilities. Meanwhile, institutional investors and wealthy households seeking higher returns are shifting out of public equities and into "alternative" investments such as private equity funds, hedge funds, real estate, and even infrastructure projects. Although we estimate that some 30 percent of assets in private equity and hedge funds are public equities, the shift is still causing a net reduction in allocations to equities.
• Growth of alternative investments such as Private equity(PE) investments: It can be also seen that the alternative investments in the form of private equity investments is also on the rise. In recent times, the IGATE buyout of PATNI has been largely contributed by the APAX partners (a PE firm). Also PE firms find it suitable to invest in emerging markets because of the low valuations, thus churning out huge amount of profits from the investments.
• Low returns in equity:Another factor weighing on demand for equities is weak market performance. The past decade has brought increased volatility and some of the worst ten-year returns on listed equities in more than a century. In opinion polls, Americans say they have less confidence in the stock market than in any other financial institution and believe that the market is no longer "fair and open.
• Regulatory changes for financial institutions:The final factor is the effect of financial industry reforms on the uses of equities by banking and insurance companies. U.S and European banks today hold $15.9 trillion of bonds and equities on their balance sheets. But new capital requirements under Basel III will prompt banks to shed risky assets, including equities and corporate bonds. Similarly, European insurers have already reduced equity allocations in anticipation of new rules, known as Solvency II, and could lower them further over the next five years.
All these reasons attribute towards an estimated equity gap of 12.3 trillion.
However there are some ways through which this equity gap can be reduced:
1. Use of structured financial products
Structured financial products can be a proposed solution to the emerging equity gap. Investors are losing their appetite in investing in equity but the use of structured products under proper financial regulations can be a good booster in equity environment.
2. Initiation of secondary market
Secondary market has been in operation in developed countries which supports the innovation led investments. E.g. NASDAQ is a secondary market for innovation led ventures. If such secondary markets can be introduced in emerging countries such as India then it will not serve as a booster for equity market but can also prove to be a good ground for young entrepreneurs as a nurturing ground to make their projects count.
3. Reforming IPO markets
IPO market has always seen down slopes since the successful IPO of coal India. It may be contributed by fragile policy making and implementation in India which has given ride to so many political scams recently. Or it may be the European crisis which has proved to be major contributor to the outflow of the money invested by the FII's. Whatever it is, the IPO market has to be regulated well for proper influx of strong sentiments in India.
The only way this equity gap can be narrowed down is by increasing the investor's sentiments towards equity in emerging countries because emerging countries has been growing at a staggering rate of more than 16 percent. And if this continues to grow like this it will be very important to engross the equity investors in emerging economies and keep the markets in balance.
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