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Commentary

We Need More Equity Investors: McKinsey

The coming shortage of equity investors by the Economist, quoting a report by McKinsey. 80% of the world’s financial assets of $157 trillion are held in developed economies, where people are ageing. Pension funds are maturing and they withdraw from equities. Emerging market investors hold most of their assets in debt, very little in equity. The crash in recent years – 10 years of nothingness in the US, 4 years in Asia, 20 years in Japan etc. – have prompted an exodus from equity markets. Finally, financial investors like banks will have to sell equities to create capital for regulatory norms such as Basel III.

This means by 2020, there is an “equity funding gap” of $12.3 trillion, unless things change dramatically. (But things will change dramatically. IMHO: There is no equity funding gap – valuations will come down to levels where they attract investors. )

US households have 42% of non-retirement financial assets in shares. The number for Western Europe is 29%; and Japan is just 10%, down from the 30% number before the crash in 1990 (since which the index is down 75% today). Most emerging markets are at about 10%.

Companies will have to fund themselves with equity but the lack of demand will propel them towards debt, says the report. About India:

Households are the largest investor class in India, holding 42 percent of financial assets—$835 billion out of $2 trillion. This money is invested almost exclusively in bank deposits, and equities accounted for only 8 percent of household financial assets in 2010. Overall, Indian household investors prefer gold and real estate to financial assets. The Indian government plays a large role in the financial system, holding more than a quarter of all financial assets. This $560 billion portfolio is largely invested in bonds and the listed equity of corporations. Banks are also investors, with $280 billion in securities. While the wealth of Indian households is expected to grow rapidly in the coming decade, the prospects for India to develop a significant equity investing culture are unclear. In 2009 the Securities and Exchange Board eliminated upfront sales charges, or “loads,” on mutual funds, which has caused distributors to pull back. Such regulations, perversely, may temper Indian investor demand for equities.

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Also, according to them, India has an equity gap of $1.8 trillion (that’s about the current GDP of India, and greater than the entire market cap of the NSE, to give you a size comparison)

The entire McKinsey report is worth a read.