Keeping one’s faith in equities as an asset class is perhaps very tough. With the markets virtually panicking and not going anywhere except down, people seem to be deserting equities. The investor who has started investing within the last decade, has made money in real estate and gold and not done very well in equities.
Equity returns are a function of three things- Patience, effort and a bit of luck. Patience is important because equity returns tend to be extremely volatile in the short term. Over longer term, I can expect share prices to reflect the underlying company performance.
Effort is required in identifying the share/s. Here it is important to distinguish between a range of characteristics that include longevity of the business, the profitability, the promoters and the nature of the business. In India we clearly see that given the growing aspirations, those companies that make and supply consumer products (especially the FMCG) are best positioned. There are services sector that grow, but are subject to intense competition as well as regulatory issues. The manufacturing and infrastructure sectors are reflective of the state of the economy and are characterised by hope and despair. So when constructing a portfolio, it is important to understand what we are buying and what kind of volatility are we going to be subjected to solely on account of company performance. We may not be able to protect ourselves against market forces but surely we can try our best to protect ourselves against the quality we pick. This effort is something people shy away from. Assuming that we are not comfortable with numbers and its analyses, surely we can spend some time in understanding the business of the company? So maybe we end up with a handful of companies we understand in terms of their longevity. Once we reach that stage, our next effort is to protect ourselves against market forces. This is best done by adopting a SIP route for the individual stock that we like. We keep buying a few shares every month for ten to twenty years.
Where we all err is in buying in bulk simply because we see others making quick money. No one tells you about the losses. Investing in equities is successful only when you buy what you like at a price that you think is right. There should be no compulsion for an individual to be fully invested. Then we become like the fund manager who says that he will be fully invested even if he knows that the markets are expensive. An individual investor has an edge, if he does his homework.
Luck is a factor that we cannot ignore. If we started our investment habit in 1995 or 1996, we have made money. If we started in 2000 or 2008 we have lost money. Timing does make a difference, if we are not a regular investor through an SIP route. We also need luck to make sure that the company we choose is not hit by fraud. We try and minimise it by knowing about the promoters, but there are no guarantees on that. We see a range of mutual funds with similar objectives, but the returns vary very widely. Again, we should be lucky to choose the winner because historical records seldom sustain.
Warren Buffet famously states that he likes to ‘own’ businesses that are first class and will do well over time, feeding on growing needs of the consumer. He also wants the business to be easy to understand. He also says that if it is not possible to buy entire businesses, he would like to be part of that by owning shares. That is what we are doing when we buy shares. We are letting our money ride on someone’s ability to manage a business well. The fly in the ointment is that the price of the share is subject to so many market forces. As an investor, we have two options to get in. One is by adopting the SIP route for a period of ten to fifteen years. The other is to be number savvy and wait for timing when the share price is really attractive or below what an analyst would call as ‘fair value’. Essentially what it means is that at this point you expect the reward (of higher prices) to outweigh the risk (of fall in prices).
The worst is to time investments with market sentiments. That way, only losses accrue to you.
24th June 2013
Today, Gold and real estate have become virtual essentials in every man’s asset creation. So much so, that these two asset classes could perhaps turn out to be the biggest bubbles over time. We all presume that we will be the smart fellow, and will bail out before the others. However, mass following, inflation and the action of governments (constant bail outs and subsidies by printing more money) ensures that these assets keep inflating in value. It is very likely that lack of faith in sovereign, inflationary pressures and crowd behaviour could keep these asset classes on the high for times to come.
Let us take gold. A metal, with no intrinsic use or value, has become a synonym for wealth due to purely emotional or sentimental reasons. And in the frenzy of speculative hoarding, it has virtually become a self fulfilling prophecy. If we take the pure extraction cost, it is well under US $ 800 per ounce. However, it has become a store of value and is driven by factors like the strength of the dollar, the degree of likelihood of an alternative to the dollar as a ‘safe haven’, Indian and Chinese household fetish for the yellow metal and the speculative forces of hedge funds and commodity funds. The other thing that draws Indians to gold is history and tradition.
Apart from Gold and real estate, there are various asset classes which get clubbed under ‘alternative’ assets. These include commodities, currencies, ‘art’, ‘antiques’ and every other exotic item that the world collects. Most of them derive value only because more than one person has a fascination for it. Take for instance, stamp or coin collecting. Since this is a passion with quite a few people, there is some value because someone is willing to pay a price for acquiring it.
The one thing to note is that these ‘alternate’ assets do not follow any predictive valuation model. It is perception and a function of demand, supply and hype. Typically, in good years, when there is a lot of money flowing around, the demand for ‘exotic’ assets goes up. In poor years, there is a likelihood of some holders wanting to exit. You cannot value these assets except look for references and prices at auctions of similar items.
These asset classes are for the ‘rich’. People who have so much money, that they already own considerable quantum of traditional assets like property, shares etc., It would be foolish if someone were to directly get in to this asset class without having put money in to the safer and liquid asset classes.
When good times roll, many of the exotics will be packaged together under the umbrella of “Portfolio Management Schemes”. There was an ‘Art” fund that was launched in 2006, which collected more than Rs.100 crores. It was supposed be a fund focused on buying, holding and selling paintings (of the art kind). It had a three year lock in period. Alas, most of the people who went in lost money. The problem is that art is a dicey investment. A new artist will command value only after twenty plus years! Established artists or old masters command fancy prices. So, unless you are passionate about it, investing in art makes absolutely no sense. Exotic investments are for those people who cannot complete a total count of their wealth at any given point of time!
The key factor is that allocation in to these exotic assets should be in consonance with your total wealth as well as the appetite for risk. If one is worried about prices and liquidity of what lies in the wealth basket, obviously these asset classes are not for you.
Exotic assets may fetch returns over long holding periods. Often, they give returns only when handed over from one generation to the next. That is the patience one should have, if you want to enter. Liquidity comes from a limited circle of investors with similar appetite.
Another thing to note in these exotic asset classes is that if one wants to buy, happy times are not the best ones. In an environment where everyone is prosperous, these asset classes tend to show a lot of demand and prices remain high. In a weak economic environment, if one has the money, these asset classes can be picked up at lower prices.
With bankers struggling to find new ideas for packaging and selling to the rich, we will see more and more investment ‘packages’ on offer. Understand the risk in the asset. And understand yourself. Are you willing to bear the risk? Is there liquidity? Who can I sell it to? Ask as many questions as possible and then take the plunge.
THE HARE AND THE TORTOISE
There is a delightful movie named “Katha” that was directed by Ms Sai Paranjpe and released in 1983. It is a modern day retelling of the old fable of the Hare and the Tortoise. In the movie, the Hare wins. The tortoise keeps going at a steady pace and the hare has its fun and games and still manages to win the race. It is like retelling the story of the Ant and the Grasshopper and the Ant coming out second best.
What relevance does it have to us as an investor? I often wonder, looking at fortunes that have been made and lost, as to if the person really followed a well articulated strategy or was he simply lucky in terms of what he picked, where he was and market timing etc. Often, I find that a systematic approach has given modest to below average results. More often than not, most investors who have had brilliant success were also the beneficiaries of being in the right place at the right time. However, the key to consistently being lucky was the ability to understand risks and at all times get a sense of circumstances.
If we take properties, you may perhaps understand what timing is all about. Often, we see property prices going up manifold in a short span of a couple of years and then stagnating for five to ten years. So, the like or dislike of property stems from when you got in and when you got out. In some cases it is also a case of did you get out at all? And we have seen properties behaving very disparately. In Chennai, I know of people whose property prices have gone up six fold in less than ten years and some whose property is not saleable even at the price that they bought, ten years ago. Was one cleverer than the other?
Similarly, for every success story of multi-baggers in mid cap stock investing, there must be at least nine stories where someone’s investment became as close to zero or gave negative returns over time. However, only the success stories go round and the failures are never talked about.
And each one of us have our own stories of what opportunities we missed, that in hindsight make us look like fools. At the time a company like Infosys was listed, for every believer there were more than ten who did not. Or it was a question of being in the right place at the right time. Those who got shares of a Colgate or a SKF at the time of FERA dilution (1974) and holding on to the shares, have seen their wealth multiply thousands of times. The same stocks, if one bought much later, did not give much returns.
PSU stocks are equally hated and liked. If you were lucky to have bought the shares when the shares were just listed and languishing in the mid nineties to early 2000s, you made a lot of money. Many PSU Bank shares were at close to or below their ‘par’ value. However, if you got in the last few years, you probably lost money or just managed to keep your principal intact.
For every investment, whether you used a SIP or a direct investment route, the judgement of timing and some luck are essential ingredients. I always feel that whilst one can use skills to choose what to buy when it comes to stock, no one has a fail safe method that will help choose the time and price. There are charts and technical analyses, but I believe that they are as chancy as a toss of a coin. That is what keeps the industry going. No perfect answers.
If you were a fan of the dot com bubble, you would either have made a fortune or lost one, depending on where you placed your bets and when you walked out of the casino after encashment. Similarly, in mid caps where I did theme based buying (land bank of old mills etc), a couple of them gave me big returns and the rest just bombed or vanished. At the point of analyses, all of them were equally bad and the bets were uniformly placed. Just a matter of luck that the greater fool theory worked in two and failed in eight instances. Someone who tracked me and happened to pick one of the two winners made very big money, many who picked up one or two of the eight, lost all and on the average, I made it fine. Better than the market, but not spectacular.
I know if I pick up high quality stocks where the companies will continue to do well with reasonable profits over the next ten years or so, my downside is limited. However, if these stocks are well discovered and talked about, the prices are bound to be high at the entry point and my returns will be nothing to write home about. Yes, I will sleep peacefully, with perhaps a minimal risk of loss of capital, but nothing spectacular to look forward to. For that, I have to get in on the ground floor before someone else does and place my bets.
Gold is a classic case of luck and timing. If we did some rational analysis, we will not consider investing in gold at all. I would rather invest in copper or aluminium since these metals have some use and value. Gold is purely for jewellery and value is based on fear and the strength of the rupee against the dollar. The last twelve years saw an unprecedented bull run in gold. Your experience depends on when you got in and got out. Skill and knowledge would have kept you out of gold altogether.
If you want to beat the market, you have to be either lucky with direct equities or brilliant at timing. If you are in mutual funds, you will average out. If you are in theme funds, your luck of timing would decide the returns. If you take an index ETF you will be in line with the market. Some diversified funds have comfortably beaten the market so again your choices expand. In choosing a mutual fund, you are forced to fall back on past performance, which is a pointless exercise. Rather choose a good high quality fund house and expect average to above average returns as compared to its peers.
In our search to preserve capital and create wealth, our search for avenues that will help us to beat inflation demands a lot of thought and effort. Simply believing in homilies like “equities beat inflation” or saying about land that “they don’t make more land” etc is pointless. We have to spend time understanding what each asset class can do. How do prices behave and what in general impact prices of asset classes. We can never perfect it the level of predicting or forecasting individual stock or land prices, but we will go in with our eyes open. This means having to spend time and effort in studying the assets that our money will buy into. Whilst it is not possible for most of us to go in to finer details, it will be a good starting point to ask “what can go wrong with the investment?”. Once we understand all (or at least most of them) the risks, then we are better equipped to handle our money.
Yes, sometimes we could get lucky like the ‘hare’ in Katha. Generally, the tortoise lives longer and wins the big races. We will make better investors if we focus more on understanding where we stand to lose rather than pick winners in 100 meter races every day. The harder one works at it, there is more likelihood of getting luckier. The key to spotting opportunities lies in understanding risks. Without understanding risks, we come down to a throw of the dice.