On April 21st, Huiman Yi, Chairman of China Securities Regulatory Commission (CSRC), convened a seminar for heads of social security funds, banking, and insurance institutions. Its theme was guiding more long-term funds into the market. The event highlighted that pension, banking and insurance institutions and various asset managers are representatives of professional institutional investors, and are the most important long-term sources of funds in capital markets.
Long-term funds entering the market give full play to the advantages of minimizing short-term market fluctuations. In fact, institutional investors have developed rapidly in China's stock market in recent years, and the weight of tradable stocks held by professional institutional investors has increased from 18% in early 2019 to 24.6% in late 2021, during which the share of various asset management products grew from 9.3% to 14.2%. This demonstrates the accelerated institutionalization of China's stock market.
Institutional investors usually are able to engage in longer-term investments, which plays an important role in the stability and development of the market. "Institutionalization" is a key indicator of market maturity, and the proportion of institutional investors in developed markets is high, on average. Globally, institutional investors generally hold a high percentage of market capitalization in traditional developed markets such as the United States and United Kingdom. The shareholding ratio of domestic institutional investors was 41% in the United States in 2019, 31% in Japan in 2018, and 26% in Britain in 2016. In comparison, according to the statistics from the Shanghai Stock Exchange on market capitalization, the shareholding ratio of Chinese local institutions was only 16% by the end of 2020.
China is still on the long journey towards "institutionalization". As of the first quarter of 2021, the calculation of A-share investor structure under market capitalization showed that the shareholding ratio of retail investors was second only to that of general legal persons, accounting for 33.27%. It is obvious that retail investors will remain leading participants in China's stock market in the foreseeable future. Therefore, the investment behavior of retail investors is also worthy of attention.
At present, the investment behaviors of Chinese retail investors show apparent short-term characteristics, as follows.
Short-term Shareholding
First of all, the direct investment behavior of retail investors features short-term holding. According to statistics from the Shanghai Stock Exchange from 2016 to 2019 (for 53.4 million retail investor accounts, 40,000 institutional investor accounts, and 47,000 corporate accounts), the average holding period of retail investors was about 40 days, whilst that of institutional investors was 109 days. In contrast, based on the monthly turnover of 22% in the US stock market during the same period, the average holding period of US investors, including both retail and institutional investors, was around 90 days.
Second, even if by means of indirect investment, the duration for retail investors to hold fund products is shorter. According to customer investment analysis of three public fund managers on their public equity funds — from the establishment of three companies to March 31st, 2021 — 45.96% held positions for less than three months, 61.6% held positions for less than half a year, only 11.46% held positions for more than three years, and only 1.73% held positions for more than ten years. Such short-term investment behavior also directly affects their investment return. A survey on fund investors by the Fund Industry Association shows that more than half of the fund investors hold for less than one year, only less than 40% make profits, and most either lose money or make no profit.
And third, according to a survey of Alipay’s fund distribution platform, 72% of the respondents were willing to hold funds for less than one year and 27% were unwilling to hold wealth management products for more than three months. Short-term holding will intensify in the case of losses. Without considering losses, 73% of the respondents chose to hold for more than 3 months, while in the case of losses, the percentage of respondents willing to hold for more than 3 months dropped to 50%.
A Set of Short-term Investment Characteristics
The behavior of retail investors in China is characterized by strong speculation, frequent trading, buying winners, and selling losers. This can be summarized as "short-term" behavior characteristics.
First of all, retail investors have an obvious speculative preference. A study based on the trading statistics of a leading securities firm in China from January 2003 to June 2009 shows that retail investors demonstrate apparent “lottery-like” preference in stock investment; this is more visible among young, male unsophisticated retail investors with high turnover.
Second, the short-term behavior of retail investors is reflected in their frequent trading. A study using account-level data from the Shanghai Stock Exchange found that although retail investors held only 25% of shares, they contributed to 87% of trading volume and traded frequently.
And third, retail investors in China tend to buy winners and sell losers in stock or fund investment. In a survey of more than 20,000 retail investors on the Alipay platform, 35% of the respondents stated that they would consider changing their investment plans when the loss exceeded 20%; if the return exceeded 20%, nearly 50% of the respondents would choose to increase their holdings. In the case of fund losses, as high as 50% of investors would only accept losses within three months, and 86% would only accept losses within one year.
In the context that policies motivate long-term funds to enter capital markets and encourage long-term investment, what impact will the short-term investment characteristics of Chinese retail investors have on individuals and markets?
Short-term behavior is detrimental to investment return, while long-term investment is conducive to building investment confidence.
Over a 15-year period ending on March 31st, 2021, the performance index of stock active management funds has increased by 910.7%, with an annualized rate of return of 16.7%. During the same period, the average annualized rate of return of retail investors was only 8.9%. The profitability of retail investments in public funds is positively correlated with holding period — with more frequent transactions, the profitability is lower. The reason why investors underperform the funds they buy is that investors frequently change their holdings.
More evidence comes from the annual "China Rising Affluent Financial Well-being Index" jointly released by the Shanghai Advanced Institute of Finance and the Charles Schwab Corporation. According to the report released in 2021, the rising affluent who started investing earlier are generally more confident in achieving their financial goals. A large percentage of respondents (42.8%) who started investing before 2011 revealed they had a good chance of meeting their financial goals. On the contrary, only 32.5% of the rising affluent who invested for the first time between 2015 and 2019 held this view. For the rising affluent who only started to invest in the recent two-year period, this figure was as low as 26.5%.
Short-term behavior of retail investors affects the function and efficiency of resource allocation in capital market, which results in a transmission effect.
The general short-term behavior of consumers when investing in financial instruments, such as frequent subscription and redemption of funds, will lead institutional investors to adopt short-term investment strategies to meet their liquidity needs. Many funds maintain high turnover to cope with frequent subscription and redemption by investors, which makes it difficult to practice the concept of long-term investment and value investment. In addition, the swing trading of the funds also results in a large number of funds pouring into a hot sector in a short time, which quickly pushes up the overall price of the sector and creates hazards for market stability.
Short-term investment has an impact on both individuals and markets, and China has been advocating for long-term investment in recent years. However, it is also necessary to realize that changing the short-term investment habits of retail investors cannot be achieved overnight. It calls for systematic and long-term investor education, market cultivation from professional institutions and product channels, and the wealth effect created by high-quality capital markets to attract retail investors that engage in long-term investment.
The meeting on April 21st put forward some suggestions for the high-quality development of capital markets. For example, it is important to drive reform of the registration system, as well as the construction of underlying systems as such in relation to issuance, listing, trading, and continuous regulation. It is essential to comprehensively promote structural transformation of capital markets — from scale expansion to quality improvement in terms of market system, listed companies, financing ratio, intermediaries, and investor composition. It suggests: improving the securities law enforcement system and mechanism; building a three-dimensional accountability system of administrative law enforcement, civil recovery, and criminal punishment; strengthening administrative law enforcement; and severely cracking down on all kinds of illegal acts. With the idea of "non-intervention", it would stimulate the vitality of market ecology and make every effort to build a predictable and fully competitive market ecology. Only with the healthy development of capital markets can the function of resource allocation be given full play. Survival of the fittest and long-term investment could then produce a wealth effect, so that retail investors would entrust long-term investment institutions or hold long-term direct investments — and in turn fully enjoy the long-term benefits of high-quality market evolution.
Author ProfileProfessor Wu currently serves as Professor of Finance at Shanghai Advanced Institute of Finance, focusing on behavioral finance and private (family) wealth management. From 2004 to 2010, he taught at Massey University in New Zealand. He was Director of the Asian Finance Association and was Special Issue Editor of Economic Systems.
