How Blockchain is changing dynamics for Stock Trading

In the recent past Blockchain has been the most talked about technology, it was originally designed to digitize and decentralize currency (Bitcoin) by using multiple ledger systems. What if there are multiple application of this technology and not just limiting it to the use of currencies. Experts over the world are now validating the use of this technology over the areas such as supply chain management, cross border trades & finance, etc.

Blockchain has gained so much attention and admiration because

  • It is decentralized, no single entity owns it
  • The data is cryptographically stored inside
  • Data tampering cannot be done inside blockchain, it is immutable
  • It is transparent

So the question raised is that can blockchain tech be used in stock trading and if yes then how will it change the dynamics of it.

Recently, SEBI has appointed a Committee on Financial Regulatory Technologies (CFRT) , exploring the possibility of using Blockchain platform in areas of post-trade settlement and fundraising. Japan is already the front runner, as it has already implemented blockchain as its core trading infrastructure at Tokyo Stock Exchange. Japanese brokerages have reportedly initiated an consortium, dedicated to adopt the process of blockchain, the founding member were Rakuten Securities, SBI Securities, Daiwa Securities and Nomura.

Back in 2015 Nasdaq, started the use of its Nasdaq Linq Blockchain ledger technology, this allows private non listed companies on the stock exchange to represent their own shares digitally. With the help of Linq and blockchain it is now possible for private companies to successfully complete and record securities transactions.

Intermediaries Minimization

A single trade between buyer and seller involve stockbrokers, depositories, bank, clearing corporation, etc. The intermediaries are for efficient functioning of the markets but they are not indispensable. Consider brokers, most of them require you to keep a minimum deposit to start an account, forget the stock trading fees, then there are other fees like option fees, etc. In a world where DIY is given so much importance such high fees is unjustified. One survey found that 9 out of 10 millennials would prefer free digital trading platform instead of a regular broker. Budget conscious investors who are unwilling or unable to buy entire shares would be happy to use blockchain powered apps which allows micro-investing.

Built in Regulation

October 24th 1929, also known as “Black Thursday”, as 13 million shares were sold in panic by the investors on NYSE. Nearly 90 years later there is no way to shape up financial sector as such incidents have had happened since then (Black Monday, Black Tuesday, etc) Perhaps blockchain will take the regulatory imperative from traders hands for goods. Users of blockchain with the help of a passkey can access the ledger remotely. Traders could save money by permitting the regulators some oversight into blockchain powered trading. National Stock Exchange (India) is also piloting on such a blockchain system for automatic KYC process.

Dividends

Some investors buy shares which gives dividends on regular basis and also who wont like some additional money coming in form of dividends. A significant portion of returns is attributed to dividends. “Cash on hand is music to an investors ears.” Automation in the dividend payment process would help the companies in saving a lot of time and money. Blockchain smart contracts help in creating process of self-executing payments. This payment will release the dividends to the customers on behalf of the companies. TMX Global and Natural Gas Exchange (NGX) are testing automatic dividend payments.

Ease in post trade events/ settlement

Over a million securities in India change hand on daily basis. The size of global investing marketplace cannot be comprehended by humans. Efficient trades settle on T+0 or T+1 day. There is need for automation in the settlement of trades happening. The way to do it maybe is with the help of blockchain powered smart contracts. Smart contracts can replace human oversight which happens in settlements of trades which by the way is also very costly. As soon as some pre-requisite is fulfilled these contracts execute. For eg. If a buyer and a seller agree on a price point the trade will be executed, resulting in shorter time lag. Shorter time lag means more money is available ko keep wheeling and dealing. Nasdaq Linq Blockchain Ledger, Australian Stock Exchange, Deutsche Borse are already using such technology for after trade settlement.

Asset Management and Fund Raising

A lot can be said about a company through its fundraising. Tesla’s management has admitted that it often runs negative cash flow. Even if the public weren’t privy to such an admission, Tesla’s relatively frequent return to the fundraising table would have clued investors in. Elon Musk’s electric car company raised $270 million in capital in 2010, $451 million in 2012, and over $18 billion total between 2010 and 2018. Experts don’t expect Tesla to be cash flow positive for quite some time. But perhaps Musk and the heads of other publicly traded companies who require capital could execute fundraising even more efficiently and cost-effectively by adopting blockchain technology next time. Companies will be able to sell stock directly to public without time constraints. Blockchain’s value comes from its ability to conduct fundraising sales and agreements without any middlemen involved. It dispatches cost-effective and immediate smart contracts to execute the transactions, saving money and time without sacrificing quality. aXpire is a blockchain powered company trying to solve this problem.

Tracking Securities Lending

Security lending is not understood by a mass of population. Traders lend ETFs or a commodity within ETF to other parties in exchange of a collateral. Nearly 3.5 trillion USD worth of ETF as of December 2018 was the market share. ETFs are considered as safe return instruments but are not so safe after all, using technology to hedge the ETFs could be critical as the market worsens. Leveraged loans that led to last financial crisis, most of the ETFs are heavily invested in such leveraged loans. For ETF manager lending securities to short seller is low stress and high upside proposition. Tracking the price of ETF is important. They can be tracked through blockchain powered ETFs, and triggers the issuance of collateral if the short seller becomes over-leveraged. Nasdaq Linq Blockchain ledger is tracking the purchase of securities.

Author
Sagar Vikmani
Team Member – Equity Research and Valuation
(M.Sc. Finance, NMIMS – Mumbai. Batch 2018-20)

Connect with Sagar on LinkedIn

How Does The 2019 General Election Results Alter The Market Dynamics For India?

The stock market indices and the share price of the companies listed on these indices constantly keeps changing due to company related factors and market-related factors. The company related factors are usually its annual performance in terms of revenue generated, market size captured, innovative product/service offered, capturing various synergies that derive its value on the index, etc. The key elements that drive the market-related factors are the macro events that take place which dictates the direction in which a particular company or the whole industry tends to move towards.

The prominent macro events such as inflation, monsoon, trade policies, financial factors, trade war, oil prices, global markets etc. are a few to name. But, one of the most crucial factors is the government that is ruling the country as it’s the epicentre of all the policies, reforms, schemes and decisions made in the country which acts as an indicator of the road which is ahead to come. Hence the importance of the motto and ambition of the incoming government is so crucial. However, the market overall will tend to thrive in the long-run irrespective as to which government comes into power.

As seen in the table below are the annual returns derived by the BSE index over the tenor of the ruling government. Here, it’s clearly visible that the returns derived from the market index have more to it than the party ruling the government.  

The markets always hope for a stable government at the Centre so as to have consistency and stability in the economy as the government is the sole authority of framing the prominent economic policies of India. The foreign players generally prefer to invest in economies that have a stable government with strong policies with long-term visibility. The Indian equities have witnessed foreign inflows worth a net of $6.7 billion from January to March, which is more than the outflows of $4.4 billion in 2018. This optimism has kept foreign investors bullish on India and the market is benefitting from huge emerging market inflows.

India is set to emerge as a USD 5 trillion economy over a period of five years and as a USD 10 trillion economy eight years after that. This gives a clear indication of the growth prospects and the sectors in which the opportunities will arise on these lines. In terms of fundamentals of the country’s economy, its inflation has come down from over 10% five years ago to about 4.6%, the fiscal deficit has come down from almost 6% to 3% which are very important indicators. We have already grown in the last five years from being the 11th largest economy in the world to the sixth. This has led to ease in the monetary policy (which we already have started to witness) which in turn can boost consumption.

To attain this kind of scales, the country needs inclusive and sustainable growth. And for this, the focus needs to be on physical and social infrastructure. The government has been taking a number of initiatives to address and correct the imbalances in both the economic growth and development of the country. BJP’s election manifesto this time around was focused on infrastructural development which has already started to witness growth from the ground level during their last tenor.

The government is expected to make a capital investment of Rs 100 lakh crore by 2024 in the infrastructure sector as well as announce a new industrial policy to improve the competitiveness of manufacturing and services. This has given a more optimistic outlook going forward. Hence, companies of sectors such as Infrastructure, Power, Capital goods, Manufacturing and Construction will witness significant progress and growth over the government’s next tenure. Some sectors such as FMCG, IT, Metals. Pharma keeps growing irrespective of the election cycles.

With the progressive economic steps of implementing Goods & Service Tax, De-monetization, the government looks to roll out further steps to organize and streamline the conduct of businesses and trades. Hence it would advisable to avoid the sectors or companies which have an unorganised structure and a low sustainability business model.

The Modi government’s return to power is likely to propel the agriculture sector stocks as well. New agricultural reforms, policies, financial aids availed to the farmers and the export policies and incentives has improved the quantity and quality of the output which can be used for domestic consumption as well as for exports.  This will leave more money in the hands of farmers which will be spent on buying tractors, cars and two-wheelers in the rural market.

The power sector has also witnessed a significant improvement in energy deficit situation over the last four years of the tenure. The country’s energy deficit, which remained in the range of 8% and 10% during 2011-13, has improved in FY14 to 4-4.5%, and subsequently contracted to a mere 0.7%.

With the implementing of Housing for All, Rural Development & Electrification, Smart City Projects, development of roadway and waterway connectivity, and many such policies being already rolled on and many being in the pipeline as well, industries that have been directly linked with these schemes and policies such as construction, building materials and accessories etc. will directly benefit from the same.

Banking sector stocks are also likely to rise since sales in the auto sector, demand for housing loans and agriculture loans will lead to a rise in their loan books. The re-organisation of the increased banking NPA’s has also propelled these stocks towards profitability. Also, banking stocks have been at the forefront of almost all rallies on the benchmark indices.

The Make in India policy and Start-up incentives provided by this government is expected to increase the employment opportunities in this market. With the kind of global recognition India is gaining throughout has been reflected by the way other economies and government is viewing India as an investment destination. This has led to strengthened relations with major member nations giving the country a much greater economic, financial, technological and political horizon to look forward to.

Though many of the investors have a different philosophy and they prefer not to try and time the stock market. They prefer to stay invested for a long time and usually have a diversified portfolio which can smoothen the impact of the immediate volatility of the market. However, analysis of this event helps to not only smoothen the immediate impact of the volatility in the market but also helps to plan the portfolio reshuffling. Thus, understanding the vision and policy-making of the government over the next tenure will help to identify the sectors that will grow in the upcoming tenor and investing in the most efficient business model of the company in that particular sector can give the investors multi-beggar returns. 

Author
Dhrumil Wani
Team Leader – Equity Research & Valuation
(M.Sc. Finance, NMIMS – Mumbai. Batch 2018-20)

Connect with Dhrumil on LinkedIn



Should I Invest In Mutual Funds or ETF’s?

It’s an age long debate as to which is considered to be better in terms of an Investment Avenue. While both happen to be reasonably good options, due to its inherent nature, a lot of times ETF’s and Mutual Funds can be used interchangeably. In reality however, it is important that these asset classes have their own nuances that make them inherently different. In our innaugral post at Finvert, we will break down how these two securities are different and what are the things an investor should consider whilst investing in any one of the two.

What are ETF’s (Exchange Traded Funds)?

As the name suggests, an ETF tracks a particular index and allows the investor to buy the entire index as it were a stock. An ETF is therefore listed on an exchange and requires a Demat account for buying and selling of the fund. This lead to the name, ‘Exchange traded fund’. Due to this, ETF returns do not significantly vary from the overall market performance. ETF’s makes an ideal investment opportunity for Investors looking to beat inflation and expecting standard market performance based on historical data. The main attraction of an ETF is an overall lower turnover and expense ratio. These factors have contributed to high popularity enjoyed by ETF’s in the U.S. but not so much in India. The size of ETF’s in India seems poultry when compared to the AUM (Asset Under Management) of the countless mutual funds on offer in the market right now.

What are Mutual Funds?

Mutual Funds are a collection of a pool of money from different investors creating a fund which is actively/passively managed by a fund manager whose primary aim is to beat the returns offered by the stock market. Mutual funds can invest in various securities including stocks, commodities or bonds. A fund manager routinely changes the asset composition multiple times in a year so as to get the desired returns. This means higher turnover and hence, high expense ratio. Price is calculated daily at the end of the day based on fund performance. The entire money invested is then converted into units and sold for money.

Mutual funds have burgeoned in terms of popularity in India due to the fantastic returns offered by the same in the past few years. Here we have taken some of the high performing ETF’s and Mutual funds of well-known fund houses and analysed the fund on various factors which include its returns, the expense ratio, percentage of stocks that are overlapping, etc. For a more like-to-like comparison, an ETF and a large-cap mutual fund is selected from the same fund house. Likewise, five ETF’s and five mutual funds are selected for the purpose. The returns calculated are rolling returns and also states the expected amount return when 10,000 are invested in the said scheme. 

Comparing a year’s return between securities is too short a term to perform a comparison. A three or a five year term is enough time to perform a comparison. Looking at the table, the most important distinction between the two is expense ratio. Where mutual funds generally charge anywhere around 1.75-2.5%, ETF’s get away with 0.05-0.15% as commission charged due to its passive nature. Add to that the turnover ratio (number of times stocks are bought and sold) of a mutual fund is high which also increases the overall expenses of the mutual fund. Things become interesting when tax comes to picture. Essentially, mutual funds are taxed yearly whereas capital gain tax on ETF’s can only be taxed when they are sold.

Overlapping of stocks in the security portfolio is another interesting thing between an ETF and a mutual fund. For eg., ICICI Prudential Nifty ETF and ICICI Bluechip fund direct growth have 74% of the stocks in their kitty that are similar. So ideally the returns for the same should match to a certain extent and that is very much the case for a 3 year period. But the mutual fund at 15.77% still manages to outperform ETF at 12.91% in the long term five year period. Another

The most important purpose of any investment is the returns generated and this is where mutual funds outperform ETF’s most of the time. The return is high but when factors such as expense ratio, stock turnover and tax come to picture, both the securities seem to offer similar returns. In some cases, ETF’s actually outperform mutual funds which question the whole idea of alpha generation in mutual funds in the first place.

While all this may look like a good picture for ETF’s, the reality is that ETF’s fail miserably in one important factor for any investor viz. which is liquidity. While mutual funds have grown to be very popular in India, ETF’s are very new and minuscule in comparison. So whilst the buying aspect may not be a problem, selling an ETF might be. So the investor needs to be cautious of this fact beforehand. But this being the stock market, no word is absolute and so both the options are to be considered by the investor while looking for an asset class to invest in.

This is not to be considered financial advice in any manner. Do your research before investing in any of the mentioned assets. Our work is limited to educating our readers regarding the same.

Kartik Tripathi
Forerunner- Finvert
(M.Sc. Finance, NMIMS – Mumbai 2018-20)
Ashish Tekwani
Forerunner- Finvert
(M.Sc. Finance, NMIMS – Mumbai 2018-20)