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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Why investing right is difficult?

Posted by Muthu on March 16, 2014

Last Friday, I had an opportunity to listen to and interact with Prashant Jain, CIO of HDFC mutual fund. As I’ve mentioned before, he is one of the fund managers I respect in the industry. He has an excellent track record spanning nearly two decades.

The topic he chose to present was ‘Why investing right is difficult?’ which was followed by a lively discussion.

This blog is about what was discussed on that day. It is based on my understanding of what was discussed and not a verbatim reproduction of what Prashant Jain said.

Getting rich is difficult even through investing. By nature, only a minority can be rich as investing right is extremely difficult.

Between 1989 and 1992, Sensex gave an absolute return of 976%. This enthused investors so much that a NFO (New Fund Offer) came in 1992 collected Rs.4500 crores. In today’s value, the NFO size is equal to Rs.20,000 crore where as the largest equity fund itself now has a corpus of only around Rs.10,000 crore.

What happened to investors who were so enthused by the 976% 3 year return and invested huge money? Even after subsequent 5 years (in 1997), their absolute return from the fund was -22%.

CNX IT (index of IT companies) delivered a return of 6119% (60 times!) during 1998-2000. Rs.1 lakh becoming Rs.60 lakh during a three year period. There was a huge rush to invest in IT companies in 2000. Investors put in a whopping Rs.10,058 crores into equity funds in 2000. Even after 5 years (in 2005), the absolute returns from CNX IT was -55%. This was despite the fact that we were in a broader bull market in 2005.

Between 2004 and 2007, CNX Infra (index of infrastructure companies) gave an absolute return of 177%. In 2007, investors invested Rs.52,701 crores in equity funds (including many infra funds). The subsequent 5 year return of CNX Infra was -19%

After the IT burst, 9/11 events etc., investors shied away from markets. In 2003, the entire fund industry was able to collect only Rs.118 crores into equity compared to Rs.10,058 crores ( 100 times more!) collected 3 years ago. This is because the previous 3 years Sensex return has been -39%. In the subsequent 5 years, Sensex returned a huge return of 413%. After it returned 413%, investors brought in huge money of Rs.50,000+ crores.

Even with gold, in recent times, most money was invested after huge run up in prices happened. The subsequent return has been negligible.

Equity investments have done very well when invested at low one year forward PE. At high forward PE, which is where most investors come and pour lump sum investments, the subsequent returns have been negative or negligible.

During last 2 years, the Sensex forward PE has been less. There has been no net inflow into equity mutual funds during the above period. In fact there has been a record redemptions of Rs.23,936 crores between April 2012 to January 2014. This is all during the time, when the past 6 year Sensex returns has been next to nothing.

The Sensex is currently trading at a forward PE of 14. This is the time to invest in equities. The next 3 year and 5 year return from here looks very good.

If we look at rolling returns of Sensex for the last 35 years, it would be clear as to why we say holding period has to be longer for equity.

Out of last 35 years, if we take 1 year rolling returns (at the end of each financial year), there has been 12 years in which Sensex has provided a negative return. For a rolling 5 year return, there has been 3 negative years. For a rolling 10 year return, there has been only one negative year. For a rolling 15 year return, there has been no negative year.

For a long period, the return becomes less volatile and is in fact stable, around 15%+ (including dividend yield, it is around 18%). This is precisely what our nominal GDP growth rate has been for many decades. If you are willing to hold long term, Sensex gives a superior return with less volatility.

For investing lump sum into equities, there has to be market timing. At low PE levels, lump sum can be invested and at high PE levels it has to be avoided. Likewise, asset allocation needs to be skewed more towards equity at low PE and less towards equity at high PE. For SIPs, there is no need to time the market. As long as the investment tenure is 10 years or more, SIP investing too would provide good returns.

Investors generally shun equity at low PE levels and embrace it tightly at high PE levels. For any asset class, investors chase the asset when the past returns has been good and avoid it when the past return has been bad. This is precisely why investors always tend to be losers. Majority, by definition is never right in any asset class. You cannot do well by buying what everyone is buying and which is very popular.

It is the responsibility of advisors to shape the investor behavior in such a way that they profit from cycles and do not become victim of the same.

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