Mood matters in investment

Mumbai: On 19th January 2020, the financial markets in India exhibited "Fear". On the 20th, the emotion turned into "Greed". What do such sentiments imply to the investors? Well, extreme fear usually signals that the markets have bottomed down, and are likely to improve. Perhaps the good time to reconsider investment positions. The outlook is exactly the opposite when the sentiments are at the "extreme greed" level. Warren Buffet suggests investors to be "fearful when others are greedy, and greedy when others are fearful."

While advanced economies have developed sophisticated measures for investor sentiments (e.g. those developed by the Federal Reserve Banks), we are yet to see significant progress on this end in India. There have been some startup-level progresses made, though. For example, smallcase, a capital market infrastructure start-up has developed the Market Mood Index (MMI) incorporating regularly updated data on FII activity, volatility, price strength, demand for gold etc. MMI is reported on a scale from 0 to 100 that measures the sentiments of the stock markets. The scale begins in the 'extreme fear' zone and goes up to 'extreme greed'.

Although new and an indirect measure of the investor sentiment, MMI shows how fast is the investment factor catching fire in the market when it comes to retail investors' decision to go for investments. Such indices are a remarkable development at a time when the capital market has been going through a volatile phase. "We will continue to develop and enable more innovative and relevant investment products for individual investors in India," says Anugrah Shrivastava, Founder and CIO, smallcase. Investor sentiment is the expectation of market participants about the future cash flows (returns) and investment risk. "Even though the stock market is more informationally efficient, investor sentiment can still predict stock returns," says Prof. Julia Freybote of Portland State University Business School, "…investor sentiment measures do not only exist for the stock markets, but also for illiquid and informationally inefficient markets such as commercial real estate."

Investor sentiment, Julia says, has been found to predict commercial real estate market returns, cap rates and market liquidity. Thus, it represents a source of information for investors to use in their pricing and investment decision-making in commercial real estate markets that are characterized by a lack of data and by segmentation (by property type and geographically). "In some markets (real estate) where, due to limited opportunities to arbitrage, anomalies may persist for a long-time rendering investor sentiment as a useful tool for prediction, and policy-making.

However, as influential the sentiments can be in predicting asset prices, beyond location specificity, they are also nuanced in measurement and efficacy," says Prashant Das, a professor at EHL, Lausanne (Switzerland). Therefore, it is high time India produced more measures of investor sentiments: both direct (survey-based) and indirect (based on financial market trends), he added.

In the past few decades, there have been radical changes in the Indian financial environment, especially in the basic structure - for example, shifting from a savings-oriented economy to an investment-oriented economy. These changes have increased heterogeneity in the composition of participants and impacted investors' risk-taking behavior.