It’s generally accepted wisdom to save aside a part of one’s salary for a rainy day. But it’s contributing to the overvaluation of equities in India.

Systematic Investment Plans (SIPs) were designed to assist investors in setting away money consistently and sensibly. SIPs take money out of an investor’s bank account on a monthly basis, investing the proceeds in mutual funds of their choice.

Over the previous 10 years, the programme has been aggressively and consistently marketed, and as a result, 90% of all contributions made to domestic equities mutual funds last year went through SIPs. According to data from the Association for Mutual Funds in India, contributions also reached a record high of 204 billion Indian rupees ($2.5 billion) in April.

The benefits of the programme are obvious, as it eliminates the need to timing the market and reduces investment friction. However, because SIPs require fund managers to purchase equities on a regular basis, they have also contributed to the Indian stock markets reaching record prices.

For example, the portfolio managers of India’s three largest multibillion dollar equity funds—ICICI Prudential Balanced Advantage Fund, HDFC Mid-Cap Opportunities Fund-Growth, and SBI Equity Hybrid Fund Regular Growth—have enough discretion to temporarily hold incoming deposits as cash, but their mandates to keep the funds fully invested frequently place restrictions on what they can do.

The portfolio managers are compelled to purchase companies even if their prices may not be as appealing as more money is allocated to these funds each month.

“This particular product, and broadly speaking, the domestic investor, has driven the upsurge in the Indian stock markets,” Mahesh Nandurkar, head of India research at Jefferies, told CNBC. “If the money comes into the funds, the fund managers obviously have to invest.”

He continued by saying that the SIPs had “driven up valuations for sure,” in addition to the underlying economy’s and business earnings’ fast expansion.

Value funds like Schroders’ Emerging Markets Value fund and Federated Hermes’ $3.1 billion Asia ex-Japan fund have been compelled to stay out of the Indian equities market due to lofty valuations. Despite India’s bright economic future, Jonathan Pines, the manager of the Federated Hermes fund, has said in the past that the country’s mid-cap equities are in a “bubble.”

For example, of the approximately 4,900 actively traded India-listed stocks, 300 had a decline in revenue during the previous two fiscal years. However, 216 of these equities saw gains over the previous 12 months, based on a review of FactSet data by CNBC.\

In actuality, small-cap businesses like Rollatainers, a maker of food packaging cartons, and Tantia Constructions, an infrastructure firm that specialises in building roads, bridges, trains, and airports, have experienced declining growth over the past three years. In the last year, however, its stock has increased by almost 300%.

That being said, SIPs seem to have more benefits than drawbacks at the moment.

Local equities markets have always been greatly influenced by foreign investors. Even while the firms that make up the index and the Indian economy have been mostly protected, the two biggest stock indices, the Nifty 50 and Sensex, have seen falls and money outflows when financial conditions have tightened overseas.

Foreign market volatility will probably have less of an effect in the future as long as the base of local investors keeps expanding.

The head of retail research at HDFC Securities, Deepak Jasani, stated that money coming in from 87 million investors who contribute around $32 a month “helps boost valuations when FPI flows are positive or neutral and helps reduce volatility caused by [foreign portfolio investment] outflows.”

There will be more. As of right moment, the amount of savings that Indians allocate to the stock market represents a very small fraction of their total yearly savings.

Indians save around 18% of GDP, or about $800 billion annually, according to Jefferies. Just $40 billion, or 5%, of this is thought to get into stocks through pension plans, insurance, and SIPs.

Investors will probably allocate a larger percentage of their savings and save more money overall as they grow more at ease making stock market investments.

According to Jefferies’ Nandurkar, “India is a low-income country, but it has a very high savings economy.”

(Adapted from CNBC.com)

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