Letter to SEBI: Solution to India's unjust IPO allotment system

Source :Sify
Last Updated: Mon, Aug 30th, 2021, 12:54:40hrs
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Savitri (name changed) is among the crores of retail investors who has actively turned to the markets for growing her money. Of course, many have in the last 15 months ever since the pandemic broke.

Savitri is as honest, conscientious, and hardworking as any of the retail investors. In fact, she is the perfect proponent of ethical and value-based investing.

When the specialty chemicals company Clean Science and Technology launched its IPO in July, she was over the moon. She spent weeks studying the company... Read its red herring prospectus almost cover to cover and was gung-ho about investing in it. She wanted to get as many shares as possible of this company at the IPO level itself. Her idea was to hold on to the shares for years and invest more over time.

Thus at the stroke of ten on 7th July - the first minute and day of the IPO, she invested the maximum allowed (under 2 lakh as per SEBI regulations) which came to 208 shares or 13 lot 16 shares each for a total price of Rs 1,87,200 at Rs 900 per share. Since she had bid for the maximum, she expected to be allotted at least one lot. She was horror-struck when she got not a single share.

Here was an investor tailor-made for this company. During down periods of the market, she’d have bought more shares of the company and never sold it, like a good investor is expected to. But now she was not just disillusioned with IPO’s per se, but this whole business of stock markets in general. She wondered: is the stock market all a gambling den as detractors say it is?

As I have written before and as any serious investor knows, there are two types of people who put money into the stock market: investors and traders. An investor is one who buys stock for the sake of the company, to help it grow. This is the basic purpose of stocks and the stock market: for people to invest in companies that are good and thus drive the growth of a nation and the world generally.

The trader, on the other hand, is in the market only to make money. He is the gambler who calculates, listens to the go-ahead given by his astrologer (you’ll be surprised how many do), or now his AI algorithm, buys shares of a company not because he cares but purely to sell it the moment its price goes up. A trader’s interest is not investment or growth, but quick personal profit. There are traders who repeatedly buy and sell stocks of a handful of companies they’ve studied thoroughly.

The job of a regulator like SEBI, as of the market, should be to encourage the investor with attractive policies over the gambler and the trader. But if you look at the IPO allotment system, it seems to do exactly the opposite.

In India, if a share is oversubscribed, you are allotted shares based upon a lottery. Thus it is not your study that will win you share allotment in an IPO – but a plain and simple lottery. What is the metaphor that the regulator is teaching both a new company being initiated on the stock market and new investors: that luck will play a bigger part than the pluck, the resilience of a company?

Secondly, shares are allotted on lots. May I ask why this mandate? Why can’t the size of the lot be reduced so that more people who want the shares of a popular company, can get it? Why can’t a company decide the lowest lot e.g. instead of the current average lot size being around ₹15,000, why can’t it be say ₹10,000 or ₹5,000? Or why should it be given in lots in the first place?  

IPO rules need to change. The message for millions of new investors entering the market due to ease of mobile investing is that the market is neither a place for gambling nor a lottery. It certainly is not a get rich quick scheme. It is a place where serious study is a winning bet. Using a lottery model – unless absolutely inevitable (these days every IPO is oversubscribed multiple times) – to decide how many shares one gets in an IPO is antithetical to this.

And what about those who are patently ‘unlucky’. Take the case of Savitri who was frustrated mainly because she hadn’t been allotted IPOs of 5 companies consecutively (she checked, nothing was wrong in the way she applied as she did get an allotment post and before this string of ‘bad luck'). Conversely, there might be those who’d have gotten ‘lucky’ getting shares in every IPO they applied. This luck factor needs to be reduced from the market as much as possible. That, I believe, should be the job of regulators whose primary role needs to be to marry investors with the perfect company.

There’ll be likes of Savitri who want clean companies, others might have a penchant for IT, some for metal companies. Like in life where people take time but eventually find and stick to their specialty, regulators can have a great role doing the same for investors i.e. guide them to their specialty over time.

But how does anyone do that with an IPO and so many new investors who know IPOs are one of the safest bets leading to almost every decent IPO getting oversubscribed multiple times over?

In the analog age, it would have been near impossible. But in the age of supercomputing thanks to superfast digital devices, doing this is easier done, than said. Here are some ideas for the same.

Idea: Democratising IPOs for Retail investors

Usually, investors who buy an IPO in the first hour, are those who are serious about that company and have studied it enough to be absolutely sure about it. The gamblers usually wait it out and invest only on the last day employing this simple logic: if a share has been oversubscribed, that means there’s excessive demand which means the price will go up on listing day. These gamblers also have another logic: why lose extra days’ bank interest?

Knowing this, SEBI could divide the hours that a share is listed in and rate them depending upon its distance from the initial launch. E.g. if an IPO is open for 3 days inside trading hours of 10 to 3.30 it means it is open for investment for 16 and a half hours in total. Thus, hour number 1 i.e. the first hour it is listed should say get 16.5 points, hour 2 gets 15.5 points till the last half an hour gets just half a point.

Thus someone who has booked in the first hour should have 16 times more chances of getting an allotment compared to someone who has booked in the last half an hour. This can be done on a minute-by-minute based e.g. 16 and a half hours is 990 minutes. Thus the one to book on minute one gets 990 points and thus has that much more chance of getting an allotment.

You can add other factors to this mathematical mix e.g. the amount one has subscribed to with the ones who have invested more, would have a better chance of getting more shares than one who has put less. Investors past IPO allotment history can also be added e.g. if someone has got allotment in the last company’s IPO, then his chance of getting in the next one should reduce based upon how much she has got instead of being a clean slate as it is now. Also can be added to this computational mix is the history of whether that person kept or sold off their IPO allotment with a person who stays invested longer past IPO listing, getting greater preference in any new IPO because this person is likely to stay invested even in the new IPO and thus will not add to the stability of the market.  

As evident, this is a complex matrix and there are more factors that could be added, increasing its complexity. This, thus, can be the perfect job for Artificial Intelligence. With AI, every company’s IPO could have some set parameters whose weightage they could increase or decrease which they can feed the AI system and thus base their allotment on that. This AI-based IPO allotment policy could even be part of the Red Herring prospectus with weightage clearly spelled out, thus turning the process that much more transparent.

A retail investor holding shares worth Rs. 15,000 for a company that is worth 15,000 crores, is like a drop in the ocean. But this retail investor starting with drops could invest hundreds of multiples of that. Thus if she gets hold of good fundamentals right from the beginning, it would be the perfect learning for her. Also, don’t they say a single leak can sink a big ship? The current luck-based IPO policy adds volatility to the market and figuring out a new, fairer method minus factors like luck, will help plug leaks and make markets that much more robust and stable.

Ultimately, that is what is in the best interests of the markets, isn’t it?

Post the heartbreak of not getting allotted shares of Clean Science.., Savitri became a sort of Devdas. No, she did not start drinking, but she began applying for the IPO of every half-decent company listing in the markets, even those whose principles she did not agree with. She hit bulls eye with Zomato even though she thought the company and the price were totally wrong. She got allotted one lot, sold it on listing day, and made enough to buy a decent smartphone. But, she’s not happy doing this and wonders if she should give up her demat account and stick to mutual funds or other methods of investment that do not involve personal heartbreak.

She reminded me of the cliché often talked about the bad prison system of India: an innocent person put into prison mistakenly ends up becoming a criminal by the time s/he is released.

And that, I presume, is not a mindset that our dear SEBI wants to inculcate in new investors, is it? So will it make the shift from a trader-focussed mindset to an investor focussed one?

(Satyen K. Bordoloi is a scriptwriter, journalist based in Mumbai. He loves to let his pen roam the intersection of artificial intelligence, consciousness and quantum mechanics. His written words have appeared in many Indian and foreign publications.)

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