A Case for Passive Equity Investments
In case some of you as investors choose to participate in growth assets without being active, here’s a simple, do-able strategy. Investors other than frequent traders can use this to plan long-term investments. First get a basic long-term plan for yourself ready. Here is our facility that some of you may be able to use. Decide what percentage of your total balance sheet (investments including real estate but not including real estate for self use) you need to put in equities, how much in debt and similarly real estate and other assets. At this stage work with percentages, do not use real figures. Sometimes absolute numbers disrupt a clear thought process. In equities you need to answer if you are comfortable investing all at one go or rather prefer a deferred investment route through systematic investment plan (STP). This route brings down risk by averaging out your purchases over a period of time.
Before you figure out a real estate strategy, it will be good to know that historically equities have out performed real estate. The same pattern is expected to continue in the future. Investment in equity is really getting a participation in profits of a company. In good phases of economic growth, businesses are likely to do well and report strong growth in profits. Investment in equities is nothing other than this-a participation in a business as a shareholder. The power of equities thus cannot be undermined and cannot really be viewed from short term sentimentally driven factors. Being invested for the long term is what will ultimately pay you off. So rather than oil, US sub prime etc, a passive long term investor should see the broad picture like where would India be in terms of physical infrastructure, quality of living and what are the basic drivers of the economic boom and how this would help corporate earnings and thus stock prices. Immediately one would tend to cut the noise of sub prime, oil etc and get a feel of the long-term benefit of equities.
Coming back to real estate strategy. Indians like many others have a natural preference for real estate as an investment avenue. Stories of investing a small sum several years back having now grown into a huge sum, are abundant. So when investors come to me I open a small worksheet and see just how big have these gains been. No doubt certain pockets have done exceedingly well but these still fall short and in the best case equal the returns of equities. Lets take an example. An investor had bought a piece of land in 1981 for Rs 500 per square yard. The same quotes at Rs 100,000 today. No doubt a great investment, but what exactly have been the returns. Well a simple calculation would show that this investor has made a return of a little over 21% over the last 27 years. A great investment no doubt. However mutual funds do not have a history of 27 years in this country but for the past 14 years the better funds have returned over 30% per annum.
This is not to discourage real estate investments but just to get the perspective right. Real estate is good from a view to diversify and have a growth asset. It may also work well over the long term for investors who wish to borrow and invest (a high risk strategy though). However equities would really out perform like it has done in the past. The sooner we realize and if we play by the basic rules of equity investing, the better it is for us.
It is indeed sad that Indians participate very little in equities. Less than 2% of household savings finds its way into equities. The low levels of awareness and education have left individual investors with a deep sense of suspicion with financial advisors and products. A generally passive asset allocation based investment strategy would help the case for investment into equities and far superior returns for investors.
What Now for the Markets
For the first time in the last few years, I have been concerned about the medium term prospects of the Indian equities. While short term movements do not bother us, the medium and long-term prospects of the Indian economy and the capital markets have never looked bleak in the last 4 years. However, now there are medium term risks. I am not suggesting that the markets will under perform but one must consider the risks and make more informed decisions.
Let me talk of the positive factors first. Over the last few months, we have seen the RBI and government take measures to reign in inflation and react to cues arising out of global factors. Interest rate increases, policy measures and active interaction (or attempted intervention) with industry were taken to insure that an overheated economy slows down. Even though it is early to get judgmental on inflation, I think the government and RBI has done a reasonable job of managing the economy. Global factors mainly the sub prime to my mind were never as important and long-term factors which would affect the country. While I am not suggesting that we would have remained completely insulated from the US recession, the driving factors of the Indian economy did not really get effected by a recession in the US. Barring a few sectors notably Information Technology, most sectors would not get affected to the extent some have projected. Since Information Technology has a ripple effect on a lot of other sectors, a special focus on the sector would have been justified. The Indian economy is growing on the strength of domestic consumption. We are net importers and hence the effect of a rising rupee bodes well for the overall economy. Yes, the patterns of consumption and distribution would change but overall the effect of a US slowdown and rising rupee would be marginal. On a comparative scale the reasoning for a marginal effect on the economy becomes stronger. India is less connected to the world than several other emerging economies.
Foreign Direct Investment is one factor that needs special mention. If we argue that FDI would slowdown and investments into the country get impacted due to global factors esp. the US, then we may need to revisit the growth projection figures again. To my mind and going by current figures, this does not seem to be a realty yet.
Unlike in the US where the eruption of a crisis has led to a recession, the slowdown in the Indian economy is engineered and comes as a reaction to global factors. The government and regulators like I mentioned have done a good job and there is nothing to suggest that the policy measures would have a lasting negative impact on the economy.
So what are the reasons of concern? While the government has done its bit to slow down an evidently heated economy, they have also resorted to political and populist measures in the past few months. Loan waivers, a burgeoning real fiscal deficit caused by subsidies on oil are measures that will adversely impact us all. Inflation this time over is largely supply driven and while there are early signs of prices receding, the government can do only as much to contain prices. Unfortunately this is coming at a time when elections are only a few months away and the government resorting to populist measures makes political, if not economic sense. Elections is yet another factor which may make markets jittery. Most fund managers are of the view that either Congress or BJP led governments would be neutral news for markets, and don’t seem to be bothered about that. However I can’t help but think how surprises have been thrown up in the past.
The main cause of worry however is oil. Not being experts on oil, I tend to buy the theory that oil demand is more or less the same and the temporary disruptions in supply should not be reasons for the markets to take prices of oil to levels where they are. However if the prices were to go up from current levels, the impact on an already slowing down economy cannot be undermined.
So what now for the markets? The direction of oil prices would more or less singularly decide the fate of equity markets in the near term. Most other concerns including elections have been factored into the markets now. Industry is already taking measures to keep earnings from slipping. It is only oil that will now decide the fate of markets in the near term. Like I mentioned earlier on, I belong to the school of thought that believes oil prices would recede (although the retail prices for consumers are almost sure to go up). If this were true, the markets are poised for more stable times. A clear signal of FII flows later in the year, and here I think there is good news, would then give a boost to markets. Investors would do well to invest at current levels but not expect early gains. Our call that Indian equities would generate 20% p.a for the next few years remains intact.
Identifying Your Investment Patterns
How do people invest? Is there a pattern which may emerge from the way you invest in markets? Is this pattern of investments correct in that does it work in favour of investors? Like any other product company mutual funds and insurance companies know customer behaviour well and design their offers so that it is easy to sell products. Nothing that we can hold against these companies but does this impact us in any manner. I think it does.
The investments markets are driven by advise. Investors get this advise from brokers, agents, advisors and media. These markets are also driven by sentiment. Ever since the steep fall in equity markets in Jan 08, mutual fund houses have turned their focus on debt schemes. The media is full of opinions on debt schemes, with articles and interviews that suddenly bring these back into focus. So is it a right time to invest in equities. My idea is not to answer this question, but to bring forth the basis of how products are sold so that they go down well with customers. At the end of it all customer is king (at least till the time he signs the cheque), so it is better to tell investors what they want to hear and get easy business than to actually offer some good advise.
In November 07, we got cautious on markets. Times were good, returns from equity high and there was a general and prolonged exuberance in markets. At a time like this, the industry knows that all advisors should be selling and selling hard, all mutual fund companies coming out with new products (NFOs) and garnering record mobilizations, there are IPOs aplenty, high valuations and complete all encompassing excitement. Someone among this big party gets up to suggest that all does not seem well. Rightly so that advice is not heard and the party continues. This is how sentiments hinder a rational thought process. Let me bring you back to current times when the market has taken a hit and suddenly investors are more risk averse than ever in the last four years. After the initial reactions settle down and companies get a feel of how long this dull phase may continue, a complete u turn is made and the focus comes back to relatively safe debt schemes. If at this stage today, I suggest that equities look good, it again may not go down well with investors and chances are that an advisor would lose the debt business that he could have got. So friends, tell investors what they want to hear and not what may be good. It ensures frequent churn (that promises more cost to the client and more revenue to advisors). Now I am not suggesting that lets be contrarian in approach. The idea is to understand and recognize how sentiments shape our investment patterns and how this behaviour gets reinforced by smart advertising and media exposures.
So is there anything wrong with advisors giving customers what they want. On the face of it no there isn’t, like I said earlier customer is king, he alone can sign the cheque so give him what he wants. Else he gets someone else to tell him what he wants to hear and give business to him. There is nothing that will change this basic sales philosophy.
So dear investors, what can possibly change is the way we buy investment products. The idea is to rise above short-term market movements. First get a clear understanding of yourself as an investor, do an exercise of asset allocation (that is deciding how much to invest in each asset class like debt, equity, real estate etc) and then take a broad long term view of equity markets. A simple common sense approach works much better than getting into complete details and overly analyzing short-term scenarios and events. So if I say how would the Indian stock markets and the economy in general look like in 2013, many investors would agree that things look positive. It is this belief that an investor should back by commiting money to equities. However if one looks only at the hourly or daily movement of the sensex, chances are factors like US Sub prime, oil prices and the high inflation figures would mar your investment decisions. Let me ask you this: 5 years ago what did the economy look like, how much was the inflation figure, what was the level of FDI and how was the rupee performing. The point I am making is do not judge the long-term merits of an investment against short-term economic situation.
If investors can do just this much, they will be able to cut out a lot of noise in the media and get more clarity on investments (as also many other products and services).