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Draw conclusions based on not one but various time periods

Conclusions should not be made based on one game. It is unfair, and it is also incorrect

Towards the end of February this year, an article in a newspaper argued that over the long term, large-cap equity mutual funds give returns similar to fixed deposits. It also stated that such tepid returns over such a long time frame go against the general investment beliefs that equities give good returns over the long term, and that the asset class has the capacity to beat inflation over suitably long horizons. The past decade’s trend depicts an opposite picture, it was argued. Worse, in a five-year period, large-cap mutual funds actually gave poorer returns than bank fixed deposits, it further stated.

Two days later, the Indian cricket team beat Pakistan in an Asia Cup match at Dhaka. Both teams combined scored 168 runs in 33 overs for 15 wickets. Out of these 168 runs, 29 were extras. That means only 139 runs came from the bat. However, even in such a low scoring match, the highest ranked bowler among both the teams failed to deliver. The bowling figures of R. Ashwin, ranked the No.1 Indian bowler and No.9 in world T20 ranking, read 3-0-21-0. He was the costliest among the Indians players and the only one who did not get a wicket. Two less accomplished spinners, Ravindra Jadeja and Yuvraj Singh shared three wickets.

What is the connection between the two events? Let us have a look.

I am yet to read a report writing off Ashwin for his poor performance in this match. Even a suggestion that Ashwin’s days are over would draw flak from many analysts and pundits of the game saying that you cannot write off a good player based on the performance of just one match. And they are right.

Conclusions should not be made based on one game. It is unfair, and it is also incorrect. But while we understand the role of chance or luck in sports, we do not understand that similar aspects have a role to play in many other areas of life—businesses and stock markets being two examples. This is exactly what we understand of the above-referred article. By taking only one period for analysis, investing in equity markets was written off.

Someone may say that we are comparing one T20 match with a decade-long performance of a mutual fund. One match is short term, but 10 years is long, isn’t it? The fact is that both events are similar because we are discussing only one period of 10 years to arrive at conclusions regarding the performance of equity markets during that period. This is a statistical mistake.

For any analysis of data, the sample size cannot be of just one. Like in case of Ashwin, this would be incorrect and it would be unfair. This is innumeracy.

This also reflects a selection bias. If I want to prove a hypothesis, all I have to do is to dig deep enough so that I find some data that supports the hypothesis.

Let us now look at another time period and do the comparison. As on 24 February 2016, the compounded annual growth rate (CAGR) of large-cap equity mutual funds and debt funds over a 10-year period was 8.80% and 7.33%, respectively. And this means that 1 lakh invested would be 2.32 lakh and 2.03 lakh in these two types of funds, respectively. However, the moment we change the time period and push it back by a year, the numbers look very different.

Let us look at the performance of both these categories as on 24 February 2015. CAGR for large-cap equity mutual funds is 15.46% and that of debt funds is 7.26%. So, someone looking at the data towards the end of February 2016 would think that investing in equity is a bad idea. The lower returns in 2016 would mean that the reward is not enough for taking the risk that investing in equity entails. However, a year back, the numbers looked mouth-watering. An analysis conducted a year back would be praising equity.

What would happen if someone invested looking at a 10-year performance of each of these categories?

Assume someone invested 1 lakh each in both the fund categories on 25 February 2015. The value of this investment as on 24 February 2016 would be 1,04,765 in debt funds and 81,571 in diversified equity funds. It is not for no reason that the mutual fund advertisements read: “Past performance may or may not be sustained in future." This line is especially important when we have a tendency to look at a single period data to arrive at conclusions.

Incidentally, we do not have enough data in the Indian equity market to arrive at a conclusion based on analysis of such data. Till then, we could keep seeing such reports.

Amit Trivedi runs Karmayog Knowledge Academy, and is author of “Riding the Roller Coaster–Lessons from Financial Market Cycles We Repeatedly Forget".

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