How to ride out a bubble (if it is a bubble we’re in)
Are Indian stocks in bubble territory? An interview given by Uday Kotak to The Indian Express (you can read it here) asks this question. Kotak is making valid points when he says that there is a wall of money coming at the market which does not have enough stocks to absorb the cash. A strong institutional flow is bringing Indian household money to the stock market through mutual funds, unit-linked insurance plans (Ulips), National Pension System (NPS) and the Employees’ Provident Fund Organisation (EPFO). This money is going into a few hundred stocks because the Indian market lacks depth. The market cap of the top stock is Rs6 trillion and that of the 100th stock is just Rs32,000 crore. The market looks overvalued on metrics of the current price-to-earnings (PE) ratio, which is much higher than the 10-year average. Valuations can go back down in two ways—markets can crash, bringing prices down or the earnings can grow; both bring the PE down. The wait for earnings has kept the market buoyant in the past few years and the wait is still on. Which will come first, the market crash or the earnings bump? As retail investors, we have no option but to give our money an equity exposure; see Table 1. But we will never have the relevant insight to time the market. We also know that markets go up and down, get overvalued, crash and then recover. See Table 2. So, is there a way in which we can ride out the bubble, if indeed there is one?
It is time to go over the rules of investing one more time. One, you must have both equity and debt in your portfolio. When markets fall, the debt part of the portfolio gives stability, reducing the hit on your money. Two, you need to invest long-term money in equity. What is long term? Table 3 tells you that if you hold on for at least 7 years, the downside is zero. The data says that the longer you hold a broad market index-based product (Sensex or Nifty exchange-traded fund (ETF), for example), the lower is your risk of a negative return. The tables shows that there has been no 7-year period in which you would have made less than almost 3% on the Sensex. For a one-year holding period, the best return was 108% and the worst loss was -56%. Increase holding to two years and the volatility falls. Hike it to four, the difference between maximum and minimum return falls even more. And so on.
How can you get these returns? Ignore greed and flavour-of-the-month product pushes. If you don’t understand mutual funds and how to choose products, just stay with a Sensex or Nifty ETF.
Monika Halan works in the area of consumer protection in finance. She is consulting editor Mint and on the board of FPSB India. She can be reached at firstname.lastname@example.org.