Equity Investment in Uncertain Times

We are in uncertain times. Global economy is taking a pause. In the US, the treasury yield curve has inverted after a decade long bull run, which typically has been precursor for a recession. Unclear direction to BREXIT is making things difficult for UK and Europe at large. China’s economy is slowing down and the trade negotiation with US will make things even difficult. IMF has recently reduced its global growth forecast to 3.9 percent.

Back in India, Demonetization and RERA have made the real estate transactions transparent with better accountability but the market is in the process of absorbing high inventory. GST system is done with its teething issues. IBC is helping clean up bad loans and Bank’s NPAs are expected to come down. Market is rewarding good corporate governance and transparency. Good news is that most of the negatives are out on the table and the things are only going to get better for economy and stock market. We have an impending election due in May and that is keeping investors’ non-committal.

So, what should an individual investor do in an Election year?

For all practical purposes, an election year should be a non-event, if you are in equity for a long haul. Things become simple if your investment duration is 10 years or more because historical data suggests that a bull and bear market cycle lasts for approximately 10 years. In a span of 10 years, you have a good chance of completing one full market cycle and hence you can avoid risks associated with “wrong” timing of the market for entry/exit. For duration less than 10 years but more than 5 years, take a judicious call on market timing with an understanding that your return may not meet your expectations. For duration less than 5 years, investment in equity is absolute NO.

Great, so should I be investing in stocks?

The answer is No and Yes. If you are investing directly in stocks to meet your financial goals and retirement then it is not advisable. If you are investing in stocks to learn how equity market works then go ahead. To put across this point, I am listing few questions.

• Are you in a position to do your own research to validate your stock selection decision, which is based on recommendations from research web sites, magazines, newspapers and media?
• Do you have bandwidth to do research e.g.
  • Go through Management Discussion & Analysis section of all Quarterly/Annual reports of all stocks under consideration
  • Gauge retail traffic by counting footfalls at a clothing outlet in a mall e.g. Shoppers Stop
• Do you know the industry dynamics of stocks in consideration?
• Do you know the impending disruption in the industry?
• Do you know the economic moat of the company in which you plan to invest?
• Do you have well-defined criteria to sell a stock (e.g. DHFL is down 80% from its recent peak. Would you wait for the price to come back up to your purchase price or consider the loss as sunk cost, do opportunity cost analysis of the investment available through DHFL, and invest in the next best investment opportunity?)
• Do you understand cyclical versus non-cyclical stocks and how their performance changes during the market cycle?
• Do you know how much is company’s Debt to Equity ratio and has company pledged any collateral e.g. shares against the debt?
• Do you have clear understanding of how the debt is being serviced?
• Have you validated if the stock market operators and promoters are not hand in gloves in mid-cap/small-cap stock of your choice?

If your answer is NO to most of these questions, then you are investing in stocks with information asymmetry and many unknowns. You can be one time lucky but would not be able to beat the market on sustained basis.

By my own admission, for every multi-bagger in my portfolio e.g. (Bajaj Finance and Astra Poly) which I used to boast about, I also had duds (e.g. Lupin, NTPC) which did not meet my return expectation, and I would not talk about.

Please get your priority right. Do you want to massage your own ego or get a bragging right to show your friends and colleagues by getting 400% return in one or two stock’s by chance or would you prefer a sustainable reasonable return on overall portfolio in long run?

If not stocks, then what?

Mutual Fund (MF) is a better option because the investment is managed by AMC (Asset Management Company). AMC’s biggest differentiation is the investment decision, which is borne out of a strong research and analysis; hence, they invest heavily in this.

You should ideally consider AMCs, who have been operating in India for long, have process and guideline aligned to mandate given by SEBI for the fund. The AMCs, who require their Fund Managers to play by the rule books and process and discourage them from taking excessive risk for higher returns. For them, AMC’s systems and process is more important than the individual brilliance, hence their focus is on less volatile, sustainable return for investors in long term. The Fund Managers leverage company’s systems and process to make smarter decisions.

For selection of fund, you should look at fund’s history. The fund should have been in existence through at least one bull-bear market cycle. The recent SEBI classification has made the historical data null and void for the funds whose mandate has changed to align with SEBI’s new classification scheme. Follow some basic guidelines while selecting a fund:

• Ensure that you pick a fund managed by Fund Managers with proven track record
• Avoid fund where there is frequent change in Fund Managers
• Review fund portfolio to ensure that portfolio is reasonable and fund is not taking excessive risk
• Risk adjusted return is more important than return
• Consistent reasonable return is more important than high volatile return
• Absolute return is not important, return versus category is
• Do not chase Star rating of funds.
• Your fund performance need not always be in top quartile
• Do not change a fund because it has gone out of favour once

What about index investing?

Index investing uses a passive approach to mimic return of broader market index. The investment can be done by investing through index Fund or ETF (Exchange Traded Fund).

Last year active funds struggled to beat index funds and that has generated a lot of uproar in investment community.  The SEBI category classification guidelines will make it even more difficult for active funds to beat an index fund.

In the years to come, index investing will be the equity investment option for masses in India as it is simple, less risky and cost effective.

In a recently conducted survey in a social media group, it was exciting to see that 93% of the members are using Equity as an investment vehicle but it was surprising to note that 71% of them are taking stock investment decisions on their own.

Over years, my personal investment journey has come a full circle – from investing in Debentures and IPOs, betting on high growth stocks, trading in Options to protect high gain, investing in mutual funds and now index funds.

My biggest learning has been to move away from complex product, mutli baggers, high return and short term; and embrace simple product, low risk, boring decisions, reasonable return, patience and long term.

 “When there are multiple solutions to a problem, choose the simplest one.” – John Bogle

The writer is a SEBI Registered Adviser and Founder of FinMyn (https://finmyn.com). He provides Fee-Only Financial Planning and Investment Advisory services. If you want to know more about him, click on https://finmyn.com/about/.