Making sense of the market noise... and then junking it
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Year 2017 saw continuing discussions about the quantum of investments from domestic investors into equity mutual funds, and more importantly, their sustainability. Industry talking heads have been frequently asked about what has changed, what is causing the huge inflow into equity mutual funds, how long this will sustain, what can make it stop, and more. In response we hear intelligent, rational, picture perfect and coherent analysis of regulatory changes driving adaption of capital market products, decline in inflation and positive real rates, low attractiveness of other asset classes, and other reasons. Then there are complex terms like financialization of household savings, formalization of the economy, generational change in attitudes and expectations, digitization of transactions and information availability, and last but not the least, to the utter delight of career asset management professionals like me, finally the realization that “Mutual funds sahi hai (is right)”. If the flow is so large (Rs1.5 trillion in calendar year alone), how can we have only one or two reasons?
When I meet investors, I hardly hear any of this. Stated or unstated, I hear only relative stuff— generating and holding cash, gold and real estate, fixed income—all alternatives are currently unattractive and equity returns in the last one, two, three (and more) years, have given double-digit returns. If just these two facts didn’t exist, all the other intelligent analysis wouldn’t matter. If equity mutual funds didn’t show great past returns, or if bank deposits were yielding 9%, knowing “sahi hai” wouldn’t be “sahi enough”.
We always think in terms of the idealistic ‘how things should be’ instead of ‘how things would be’, or the more practical and probabilistic ‘how things could be’. The yawning gap between what professionals think and what investors are actually being driven by, must set the agenda for all of us.
As professionals, we need to be mindful of what’s driving investors—relative return on alternative asset classes and past performance of equity. There are short cycles and long cycles, and once in a century maybe there are super-cycles; but eventually every asset class reverses its great runs towards the historical average. We need to watch for anything that can make other asset classes more attractive or cause a dent in equity returns, that is, a sharp and sustained correction from the current levels. That entails setting right expectations along a range of probabilistic outcomes—from an absolute decline of 10-15% in any window of time up to 10-15% compounded gain over next few years. Anything better is surely not ruled out in these transformational politico-economic conditions but setting expectations conservatively will hold everyone in good stead. Clear guidance is required on investing gradually as well as investing only those monies that can be spared without recourse for minimum 5 years. After all, every investment that professionals make is based on some hypothesis of corporate and economic performance and we need our investors to be with us for a time frame over which such strategies can fructify. Performing well is half the job done; enabling investors to stay firmly in the saddle is the more important half.
You as an investor, on the other hand, should think like an investor; without bothering about intelligent explanations of what supposedly drives you. You are definitely driven by some objective investing goals but do introspect to ensure there is no mental overlay of the greed for more, the fear of missing out, relative comparisons with friends, and thinking of probabilities as if they are certainties. Equity investing is always probabilistic and these mind games play havoc at market extremes.
If you have been invested for long, expecting ‘teen’ returns from equities but present returns are in excess of the recent few years’ average; you can stay the course with your SIPs but keep your asset allocation in mind. If that entails booking profits and shifting money to debt instruments, then do that. If you are under-invested in any asset and you need to correct your exposure (by booking profits from the one that you are in excess of), you cannot do it overnight. Draw out a plan over time to gradually correct the asset allocation. Asset allocation is far more strategic than merely being overweight in the asset class that has been doing well and being underinvested in the one that has not done as well.
Over the years, inflation has dropped from 8-9% to 4-5%, interest rates on savings have declined from 9-12% to 6-8%. Hence, nominal returns across all investments, including equity, should decline though you get better inflation-adjusted returns today. The gravest of investing errors are caused chasing high returns in a low-return environment. See the weighted returns on your total investment portfolio—Public Provident Fund, fixed deposits, non-term insurance, fixed income, gold, property, and equity—vis-à-vis returns required for your goals. Do not make decisions based on how one component has been doing of late.
On the other hand, if markets correct by 10-20%, remember that you have been waiting precisely for a correction to invest (I gather everyone is). SIPs are registered precisely to take benefits of a market fall. Celebrate the market fall. It may temporarily look bad on your current investments but it will augur well for the future. As the saying goes, all past corrections look like missed opportunities; except this one.
And remember what happened last month, quarter or year doesn’t determine what will happen in 2018.
Aashish P. Somaiyaa is managing director, Motilal Oswal Asset Management Co. Ltd