Insights

Long is the name of the equity game

July 26, 2013 . Vidya Bala

Even as all eyes are glued to the debt market, the equity market has its own story to tell, if we care to listen; what with forward valuations (price earnings ratio) lower than long-term averages (at about 15 times), seen since 2001.

Yes, there are enough near-term concerns for equities. Besides the shape and health of the economy and certain sectors, the recent tightening of liquidity could make it harder for companies to meet their funding needs, whether working capital or capital expenditure. Then there are the elections, providing uncertainty to development work in the country. That means a good part of FY-14 may be reeling under uncertainty.

But then, equity was never meant to be a short-term game.

Still, somehow, most retail investors think otherwise. Result? Jumping in to the equity market euphoria just as markets turn expensive and then exiting when markets topple thereafter and look cheap.

The majority ill time it
Here’s some interesting statistics on how investors put more money in equity funds at the peak and then stop the flow altogether later. The table below clearly illustrates the poor response to equity funds in down markets, such as the ones in FY-03 or FY-13, when valuations were very attractive.
equity sales
Conversely, money flowed in to equity funds rapidly in peak markets such as FY-08, when price earnings ratio was upward of 20 times.

Now the question is: how would you know that it was a peak market? Fair enough, unless you follow markets/valuations, it may be tough. But then, why did investors stop investing when they knew the markets fell? This happens simply because people either invested in lump sums during market euphoria and did not bother to revisit in down markets or stopped their SIPs in panic, when the markets fell.

Now this is where pure investment discipline, if nothing else, rules.

The bounce back
Okay, let us suppose, your risk appetite would not let you throw, what may seem to you then as, good money after bad. But had you held on to what you had invested, chances are that you would still have made money. Given below is the Sensex data on the fall in down markets and returns 2 years after such down market.

calendar after fall

Clearly, barring the years after the Y2K fall, markets have mostly compensated in the 2 years following the years’ of bear market. And we are simply looking at the Sensex. A basket of well diversified equity funds coudl have fetched much more in the above periods. Hence to say that your investments never made money may not be entirely true.

The no-loss territory
Agreed, again, that your skepticism in equities may be justified if you compare the returns of this asset class, in recent years, to other asset classes, including debt and gold. But then, that’s how equity markets have been earlier and will continue to be. Equities are simply for the long haul. Just take a look at the data below for the Sensex since 1980.

rolling latest

The rolling returns across various holding periods are given. Returns were rolled on monthly basis. The data shows that the probability of getting negative returns was as high as 30% for a 1-year period and 0% for a 15-year period. The probability keeps diminishing with time. In other words, the longer the holding period, the better the chances of not losing any money. And the average returns look good enough too.

What it all means
So does that mean you should never be holding equities if you had goals over shorter periods of say 3 years or 5 years? Not so. Its about the proportion you hold. It’s that proportion which would gently prop up portfolio returns if markets do rally and not actually harm your portfolio in case things take a turn for the worse. This is why a proper asset allocation becomes the determining factor when you have short- to medium-term goals.

Asset allocation to suit your time frame and systematic investing could be the only way out to play the equity game.
Else? Staying invested in pure guaranteed traditional debt products could be the only option. But then, you can be reasonably sure that they would lag behind rising prices, whether it is education or retirement.

If your parents managed it, they did so at a time when post offices and deposits gave a 12-13% interest and most of them drew pensions. So just how do you propose to manage with an average 6-8% post tax return on your fixed return products and no pension to think of?

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