EQUITY INSIGHT

Independent equity research brings shift in investor behaviour

Rahul Nagpure Analyst, CRISIL Research Tarun Bhatia Director, Capital Markets

September 2011

Disclaimer CRISIL Research, a Division of CRISIL Limited has taken due care and caution in preparing this Report. Information has been obtained by CRISIL from sources which it considers reliable. However, CRISIL does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. CRISIL is not liable for investment decisions which may be based on the views expressed in this Report. CRISIL especially states that it has no financial liability whatsoever to the subscribers/ users/ transmitters/ distributors of this Report. CRISIL Research operates independently of, and does not have access to information obtained by CRISIL's Ratings Division, which may, in its regular operations, obtain information of a confidential nature which is not available to CRISIL Research. No part of this Report may be published / reproduced in any form without CRISIL's prior written approval.

Independent equity research brings shift in investor behaviour

Investor behaviour in the Indian equity market has undergone a shift with increasing usage of independent equity research for making investment decisions. According to a recent study conducted by CRISIL Research, understanding the fundamentals and having access to additional information on the company are evolving as key drivers of investment decisions. An analysis of 100 companies covered by CRISIL Equity Research reveals an increase in their traded volumes after the release of their CRISIL equity reports over pre-release volumes. Average daily traded volumes of CRISIL-covered companies increased by 12% for the one-month period post release of reports compared to the corresponding period before release. The rise in traded volumes was sharper for mid-caps (36 companies with a market cap between Rs 5 bn and Rs 50 bn) at 32% and even more significant at 43% for small caps (57 companies with a market cap of less than Rs 5 bn). The study confirms independent researchs catalytic role in increasing liquidity in small and mid-cap stocks, thus driving the process of value discovery.

Background
The Indian equity market has been historically underserved by equity research. Industry data indicates that out of 6,000 plus companies listed in India, 90% are not researched at all. Further, more than 99% of these un-researched companies are small and mid-caps with a market capitalisation of less than Rs 50 bn. With most of the research being focused on large cap companies, investors in small and mid-cap stocks face a dearth of adequate information to make a learned investment decision and have limited knowledge of the companys financial strength, management capability and corporate governance standards.
Figure 1: Research coverage of listed companies
(No. of Companies) 6,000 5,319 5,000 4,000 3,000 2,000 1,000 0 0 1-5 6-10 No. of Analysts 11-15 16

390 92 59

179

Source: Industry, CRISIL Research

To address this dearth of quality research and independent analysis, CRISIL introduced the concept of Independent Equity Research (IER) in September 2009. As part of its equity research process, CRISIL carries out a detailed assessment of a companys business and industry prospects, as well as its financial strength, management capability and corporate governance practices1. CRISILs experience indicates that consistent research provides companies with increased liquidity, increased transparency and enhanced visibility among investors, thus helping the researched company gain easier access to capital.
1

CRISILs equity research approach, the list of companies under coverage and the detailed reports along with quarterly updates are available on www.crisil.com

Impact of CRISIL reports on traded volumes

To gauge the effect of CRISIL equity reports on liquidity and investor awareness of the researched company, we studied the trend in a companys traded volume before and after the release of CRISIL equity research report. The study sought to assess the response of the market to the concept of independent equity research. We analysed the impact on traded volumes for just one month after the release of the report as we believe that within this period new information is absorbed in the market; beyond this period, however, other externalities get factored in.

Methodology
The following methodology was adopted to measure the impact of CRISIL equity reports on traded volumes of researched companies: a) The release day of a company report was defined as the 0th day for the company, and its daily traded volumes2 were tracked from one month (20 working days) before the release to a month (20 working days) after the release. This was done for 100 companies on which CRISIL has equity research coverage. b) The traded volume data for different companies was stacked side-to-side (with the 0th day for all companies coinciding). The volumes were then added horizontally for each day to arrive at the total traded volumes for the portfolio of companies on that day. c) The daily average of the total traded volumes for the portfolio was calculated for one month before the release of the reports and compared with the same calculated for one month after the release of the reports. A similar comparison was made for the pre- and post-release volumes for the one-week (five working days), two-week (10 working days) and three-week (15 working days) periods.
2

Key findings
The analysis reveals that companies under CRISILs equity research coverage logged an increase in traded volumes post the release of their reports. The impact has been more prominent for small and mid cap companies. More than half of small and mid-cap companies under CRISIL equity research coverage recorded an increase in traded volumes. 31 small cap companies (54%) logged an increase in traded volumes for the one-month period post release of CRISIL equity research reports 19 mid-cap companies (53%) logged an increase in traded volumes for the one-month period post release of CRISIL equity research reports

Volume traded on the National Stock Exchange (NSE) for 84 companies and volume traded on the Bombay Stock Exchange (BSE) for 16 companies

Charts in figure 2 show the average growth in traded volumes for CRISIL-researched companies (also categorised into small and mid-caps) over one week, two weeks, three weeks and one month after the release. Average daily traded volumes increased by 12% for the one-month period post release of CRISIL equity research reports. For small caps, average daily traded volumes increased by 43% for the one-month period post release of CRISIL equity research reports. For mid-caps, average daily traded volumes increased by 32% for the one-month period post release of CRISIL equity research reports. The sharpest impact was witnessed in small caps over a two-week period. The average daily traded volumes increased by 66%.
Figure 2: Growth in traded volumes post release of CRISIL equity reports
(Change in traded volumes) 70% 60% 50% 40% 30% 20% 10% 0% 1 week 2 weeks 3 weeks 1 month 15% 47% 43% Small caps under CRISIL equity coverage (57) 66% (Change in traded volumes) 35% 30% 25% 20% 15% 10% 5% 0% 1 week 2 weeks 3 weeks 1 month 21% Mid caps under CRISIL equity coverage (36) 32% 29%

20%

(Time elapsed post release of report)

(Time elapsed post release of report)

(Change in traded volumes) 14% 12% 10% 8% 6% 4% 2% 7%

All companies under CRISIL equity coverage (100)

Volumes (mn) 50 12% 40

10% 8% 30

20

10

0 0% 1 week 2 weeks 3 weeks 1 month -1 month -2 weeks Volumes (small caps) Volumes (mid-caps) Volumes (all) Release +2 weeks +1 month

(Time elapsed post release of report)

Average (small caps) Average (mid-caps) Average (all)

Source: CRISIL Research, NSE, BSE

Average daily traded volumes across all categories of companies registered an increase post release of their CRISIL reports. The significantly higher impact of these reports on the traded volumes of small and mid-cap companies emphasises CRISILs value proposition of increasing their liquidity and transparency along with catering to investors underlying need for information about these companies.

Reduced transaction costs

Apart from positively impacting traded volumes, increase in liquidity also reduces the transaction costs (measured by the average bid-ask3 spread to price ratio) associated with the stock. This lowers the entry barrier, consequently attracting more investors and, thus, creating a self-perpetuating cycle driving liquidity. This effect is confirmed by the reduction in average transaction costs observed for the researched companies post-release of their CRISIL reports.
Figure 3: Average bid-ask spread/price ratio
1.2% 1.1% 1.0% 1.0% 0.9% 0.8% 0.7%

0.6%

0.4%

0.2%

0.0% Small caps Before CRISIL Equity Report Mid caps After CRISIL Equity Report

Source: Industry, CRISIL Research

Conclusion
The positive response of investors to CRISILs independent equity reports underscores the value found in these reports, especially by investors in small and mid-cap companies. It also highlights the strength of CRISILs emphasis on independent evaluation of companies fundamentals. The study accentuates CRISILs efforts towards transforming equity investing in India into a more fundamentals-driven and information-supported activity than it has been so far. As capital requirements of companies increase with overall growth of the economy, the importance of independent equity research will only amplify as companies increasingly tap into the equity market.

The bid price is the price that a buyer is willing to pay for a security. The ask price is the price that a seller is willing to accept for the security. The bid-ask spread is the difference between the bid and the ask price.