After turning their back on domestic equities for five years, Indian retail investors have finally begun to dip their toes back into the market, a trend that could help sustain the bumper rally seen over the past year, say strategists.
"Retail investor could be the next big thing," Aditya Narian and Jitender Tokas, analysts at Citigroup Global Markets wrote in a note.
Domestic flows into equity mutual funds surpassed 108 billion rupees in July – the third straight month of net inflows - compared with outflows of 18 billion rupees in the same month a year earlier.
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Retail ownership in BSE 500 companies, which represent over 90 percent of the total market capitalization on the Bombay Stock Exchange, stood at approximately 15 percent as of the end of June, according to Citi. By comparison, foreign institutional investors, a primary driver of the market's upswing in the recent months, hold around 22 percent.
India's benchmark Sensex index has surged 24 percent this year fueled by optimism that Prime Minister Narendra Modi, widely regarded as investor friendly, will push through reforms needed to revive Asia's third largest economy.
The rally, however, has stalled in the past two months owing to a number of factors including higher investor risk aversion stemming from rising geopolitical risks and disappointment over a lack of details in Modi's maiden budget.
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Strategists expect retail participation to increase in the coming months alongside further gains in the market.
"As the market picks up momentum you'll see money coming in larger sums. Retail investors are creatures of momentum," Saurabh Mukherjea, CEO, Institutional Equities, Ambit Capital told CNBC.
"It's an age-old pattern that once a bull market is a year old, retail investors start coming into the market," he noted.
Another impetus for retail investors to ramp up exposure to the equity market is the relative performance other asset classes such as real estate, fixed income and gold.
Gold priced in rupees, for example, have fallen more than 1 percent over the past year, making investments in the equity market look far more attractive.
Warning for retail investors
With the market having run up substantially over the past year, it's important for retail investors to focus on companies with solid fundamentals, said Mukherjea.
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"Like in many markets, Indian retail investors tend to come in late to the party and get attracted to the dodgiest type of stocks that fall the most in a correction," he said.
"I would urge retail investors to buy good quality names – small and mid-caps – with a 3-4 year horizon rather than trying to make a quick buck," he added.
Mukherjea has a bullish outlook for the market, forecasting the Sensex to hit 30,000 by March 2015 – 15 percent upside from current levels – driven by a pickup in both growth and reform momentum.