If we look closely to the pattern of stock market returns, they are neither stable nor steady. There have been many ups and downs in stock market movements; 8 out of 12 years have produced a return of more than +/- 20% in a year. This is because emerging market indices are typically more volatile when compared to those of developed markets.
While there is much excitement in the market about the stock market looking up and because it seems the immediate future looks better than the recent past, the average investor is unsure and uncertain about how to plan his investments. To help address this, and based on my 25+ years of workex in the financial services/fund management space - here is some background, perspectives, tips and ideas that I hope will help retail investors understand, appreciate and finally, navigate the uncertain future better.
Let’s start with the good news.
The Sensex (the barometer of the Indian equity market) has posted spectacular return of 18% during the first seven weeks of 2012.
With a compounded annual return of around 16% over the last 30 years and 18% over the last 10 years, the Indian equity market is one of the most attractive investment destinations in the world in terms of risk adjusted returns. Sensex yielded positive returns in 23 of the last 30 years – better than most other markets. In fact, Rs.100 invested on April 01, 1979 (the base value for Sensex) would have grown to Rs.18, 428 as on 21st February, 2012.
But is the picture that rosy?
If we look closely to the pattern of stock market returns, they are neither stable nor steady. There have been many ups and downs in stock market movements; 8 out of 12 years have produced a return of more than +/- 20% in a year. This is because emerging market indices are typically more volatile when compared to those of developed markets.
So why is the Indian Equity Market volatile?
1) Being an emerging economy, the capital market of India is not yet mature. The depth in Indian equity market is lower compared to developed markets. This can be attributed to lower average daily volumes of around Rs. 150,000 crore in National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) put together - which is much lower compared to the trading volumes on large international exchanges like the New York Stock Exchange (NYSE) or the London Stock Exchange (LSE).
2) After the financial decontrol activities were carried out by Finance Ministry in the early 1990’s, foreign capital inflow/outflow was allowed without much difficulty. This has led to an inflow of a little more than USD 100 billion of Foreign Institutional Investor (FII) money to Indian equity market over the past 11 years. As large inflows of this “hot money” leads to sudden rise in equity indices, similarly heavy outflow due to global uncertainty does have a sudden negative impact on equity market performance.
3) Daily trading volume in futures & options segment is approximately 10 times that in cash segment, which indicates a rise in speculative trading activity giving rise to volatility in certain stocks.
Does that mean we should shy away from investing in equities owing to volatility? The answer is a clear “No”.
The Indian economy is deemed to go through a sweet patch for at least next 10-20 years owing to the following macroeconomic factors.
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As per the famous BRIC report, originally published in 2003
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India will be one of the four dominant economies by 2050
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India’s growth rate shall be the highest by this time.
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GDP of India shall overtake Japan by 2032 and USA by 2043
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Between 2007 and 2020, GDP per capita of India should increase 4 times
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Our currency could appreciate by 300% over the next 50 years
Consumption
- As a result of a 300 +million-strong middle class: consumption is expected to triple as a share of total consumption over the next 15 years
Infrastructure & Investment
- Infrastructure spend budgeted in the 12th five year plan is USD 1,000 billion which will lead to rapid growth of economy and rise in corporate profits
Outsourcing (Technology)
- 50% share in the global offshore IT and BPO services;
- 220 of the fortune 500 companies source software from India
Young India (Human Capital)
- India has the 2nd highest workforce (478 million) after China (820 million)
- Number of workers expected to be added by India by 2020 is 110 million compared to 15 million by China over the same period
- Average age to remain 25 years for next 20 years
Domestic Savings in India is projected to stay firmly above 30% of GDP - leading to higher ability of private/government spending
Then how does one beat the volatility and earn consistent returns in the Indian equity market? As Indian market get increasingly integrated with global markets, volatility is likely to increase. Wild swings in equity prices provide opportunities to buy stocks cheaply and sell when overpriced. Now you are probably saying - this is easier said than done!
Here are some suggestions that can help you do just that:
Asset allocation strategy
Thumb rule for investment in equity:
- Percentage investment in equity = 100 – age of the investor. Remaining amount should be invested in Govt. Security/Corporate Bonds and Gold which will give you guaranteed returns
- Investment in equity market should be done on an SIP (Systematic Investment Plan) basis. Every month a certain investible amount should be put aside for investment in equity. A systematic investor who would have invested when Sensex was at 170 in 1981 would have reaped the most benefit when Sensex reached 21,000 in 2007.
- Three factors should be kept in mind while investing in a stock – Safety, Liquidity and Returns. It is advised that a retail investor should invest in large cap companies with focus on domestic growth (e.g. sectors like Banking, Auto, Infrastructure and Capital Goods) and with a track record profits and dividend for say last 5 years
- Investment in equity market should be done only with a medium to long term time horizon i.e. investment for at least 3 years. Short term investment or trading more often than not, makes losses for a retail investor
- Investors not able to directly invest in stocks could participate in Indian equity market through diversified ULIPs or Mutual Funds.
International analysts believe Indian market will remain a preferred investment destination for the next 10-20 years given its strong economic fundamentals. Investors with moderate risk appetites should participate in the Indian equity market, despite volatility, to reap inflation-beating handsome returns in the years ahead.
By Dr. Nirakar Pradhan
The author is CIO, Future Generali India Life Insurance Co Ltd.