Indian mutual funds are dramatically increasing their exposure to initial public offerings (IPOs) as attractive investment opportunities shrink in the overvalued secondary market. With robust retail money flowing into equity schemes, fund managers are turning to primary market issuances in search of better returns, despite concerns about lofty valuations and questionable long-term commitment.
Record IPO Investments Amid Market Challenges
Mutual fund investments in IPOs surged by 38% to ₹25,966 crore in the first ten months of this year compared to the same period last year, according to data from Primedatabase.com. This significant increase comes at a time when the share of mutual funds in total money raised via IPOs has climbed to 20%, up from 18% a year ago.
The trend contrasts sharply with other institutional investors. Foreign Portfolio Investors (FPIs) saw their participation drop to 26% from 31%, while insurance companies reduced their share from 6% to 4%. Only financial institutions and banks marginally increased their involvement from 3% to 4%.
This shift occurs against the backdrop of a buoyant IPO market, with companies raising ₹1.3 trillion till October compared to ₹1.03 trillion in the same period last year.
Driving Forces Behind the IPO Rush
Several factors are pushing mutual funds toward IPOs. Continuous retail inflows have created pressure to deploy capital efficiently. According to Association of Mutual Funds in India (Amfi) data, mutual funds received ₹2.91 trillion in net flows in equity schemes so far this year, slightly lower than ₹3.16 trillion in the year-ago period but still substantial.
Pranav Haldea, managing director at Prime Database Group, explained: "Mutual funds have to make use of the continuous flow of money from retail investors, and hence we see asset managers investing increasingly in IPOs."
The sluggish secondary market performance has also been a key driver. The Nifty 50 has returned around 8% in the ten months ended October but hasn't been able to touch its September 2024 high since markets began correcting.
Umeshkumar Mehta, CIO at Samco Mutual Fund, highlighted behavioral factors: "If something is served to you on the table, you are slightly more inclined to buy that rather than the already existing 1,000 stock options in the secondary market, where research is needed. There is this human behavioral and recency bias towards IPOs as they are talked about a lot in the media."
Valuation Concerns and Exit Patterns
Despite the enthusiasm, concerns persist about mutual funds investing in companies with steep valuations. The recent Lenskart IPO, where most mutual fund houses participated despite a valuation of 260 times, drew criticism from investors on social media platforms.
More troubling is the pattern of early exits by mutual funds. A Mint analysis of the top five IPOs that mutual funds bought by value reveals that many funds have already sold their positions shortly after the lock-in periods ended.
In HDB Financial Services, where 65 mutual funds participated as anchor investors, 32% have completely exited the stock. Similarly, 35% of mutual fund anchor investors in Ather Energy and 26% in Hexaware Technologies have sold their entire holdings.
This raises questions about whether mutual funds are truly committed to the long-term growth stories they often cite when justifying high valuations at the time of IPO investments.
Structural Challenges and Market Dynamics
George Thomas, fund manager at Quantum Mutual Fund, pointed to the size problem: "Because of the continuing flows, the size of many funds have become larger than what they can absorb and in such situations it becomes difficult to allocate in the open market without impacting the prices."
IPOs offer mutual funds the ability to deploy sizable amounts without facing liquidity constraints that might affect secondary market purchases. However, Quantum MF maintains a house view of avoiding IPO investments, believing most leave little room for long-term gains.
Siddarth Bhamre, head of institutional research at Asit C. Mehta Investment Intermediates Ltd, described the phenomenon as a "function of a bull market" where promoters seek richer valuations while fund managers chase alpha in primary markets when secondary markets become expensive.
The trend also highlights structural issues in the mutual fund industry. Most funds lack capacity guardrails on how much flow they can absorb, and even those that understand their capacity limits often choose not to halt additional flows to protect management fees tied to assets under management.
Global Investors Take Cautious Stance
While domestic mutual funds rush into IPOs, foreign institutional investors remain cautious. Dhananjay Sinha, CEO and co-head of institutional equities at Systematix Group, noted that FIIs are underweight on India because valuations remain expensive while earnings growth moderates amid slowing demand.
India trades at a trailing price-to-earnings ratio of 23x, compared to China's CSI 300 index at 17x, though similar to the US Dow Jones at 23x. However, markets like the US and China offer better profit growth alongside these valuations.
Sinha added: "Despite GST cuts, we haven't seen any significant consumption pick-up. So, returns may be statistically higher than last year, but Nifty 50 earnings growth will be around 6%."
This divergence in approach between domestic and foreign investors highlights the unique challenges facing Indian markets and raises important questions about the sustainability of the current IPO investment trend among mutual funds.
