Why investors do not make good returns II

 It has been time and again established that good returns are seldom made on investments made in good times. Rather good investments are typically those that are made in adverse market conditions.

There is a fair value of companies—both for listed and non-listed. When the economy is booming companies trade above their fair value and below the fair value when the economic condition is not good just like the present times. 

Markets revert to the mean or fair value over long term. They do not sustain at either overvalued or undervalued levels.  Hence, if they do revert to fair value only then will an investment made during bad times yield good returns.  

Given below is the proof that good investments made during adverse market conditions (when P/E ratio is low):-

Table 1:

Y.E. 31ST March	Sensex	I year Forward P/E	3 year CAGR (%)	5 year CAGR (%)	EVENT	Equity MF Inflows (Rs. In cr.)
2000	5001	24.20	(-)15	5		10058
2001	3604	15.80	16	26		22161
2002	3469	12.10	23	30	Global markets meltdown in aftermath of 9/11 attacks. Unexpected NDA defeat	8763
2003	3049	9.20	55	39		118
2004	5591	12.50	33	12		7205
2005	6493	12.00	34	22		7398
2006	11280	15.90	-5	12		36155
2007	13072	15.40	10	6		29916
2008	15644	20.30	8	4		52701
2009	9709	12.10	21	NA	Sub prime crisis. Collapse of Lehman Bros	4084
2010	17528	17.70	2	NA		1456
2011	19445	17.40	NA	NA		(11795)
2012	17404	14.20	NA	NA		504
2013	18836	14.00	NA	NA	QE tapering Concerns on Indian economy High inflation Falling rupee High fiscal deficit & CAD	(14731)

(Source: - HDFC Mutual Fund)

  

Is high P/E investing the only reason why investors do not make good returns? We AT AIMS believe there are other factors that lead to low returns for investor. Some of them are as under:-

• Decision to buy based on past performance: - A majority of investors/prospects that we have met to date invariably look up past performance before taking the buy decision. If the fund has performed well during the past, then they strangely enough feel confident to invest. Disclaimer made by mutual funds that past performance may or may not be sustained in future is usually overlooked. They forget that you cannot drive a car by looking at the rear view mirror.

• Bankers are more knowledgeable compared to IFAs: - The common perception amongst the investors is that bankers are more knowledgeable than IFAs. They feel more comfortable dealing with banks rather than their friendly neighborhood advisor. There are innumerable stories of gullible investors having been mis-sold investment product by their banking RM.

• Flight to “safety” during downtrends:-  Over last 1-2 years fixed deposits and tax free bonds have witnessed record inflows, contrast this with the fact that equities has seen huge outflows and closure of folios. As a result, investors do not have liquidity to buy equities when the market is low.

• High P/E investing is good (?):-How can an Indian MF investor hope to make money when he buys high and sells low. Indian Mutual Fund industry has got record inflows only during the period P/E were at all-time high. In Indian context, a P/E ratio of up to 15 is considered to be safe zone for investing, while a P/E between 15-20 is considered to be cautious zone; and beyond that is considered to be red zone. A look at Table 1 above shows that while inflows were mere Rs. 118 crores in 2003, they rose dramatically to Rs. 52700 crores during 2008 when the P/E were 9.20 & 20.3 respectively. Inflows into equity MF again were reduced to a trickle in 2012 to mere Rs. 504 crores.

• Does FII have more faith in our economy than we do: - We always tend to blame FII when our markets go down! We still haven’t found answer to the eternal question--- what will happen to the market if FII decide to exit lock, stock & barrel? If they haven’t exited after 20 years of upheavals, then we believe chances are they are here for good!

Despite many ups and down in the Indian and world economy, FIIs have been consistent in their investments.  They have withdrew only on a few cataclysmic events like

•     2002 on the eve of global meltdown due to  9/11 attacks
•     2009 due to economic crisis in USA & collapse of Lehman Brothers.

 Looking at the FII flows in India, one can easily conclude that they are more confident of the Indian economy than us. Over less than 2 decades, they control about 20% of our equities.

Y.E. 31st. March	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011	2012	2013
FII owner ship	13	13	16	17	19	20	18	15	17	18	19	21
FII flows (Billion $)	1.70	0.50	9.6	9.40	11.1	5.80	13.10	(11.00)	23.40	25.20	8.40	25.90

(FII’s were allowed to invest from September 1992 onwards; shareholding of FII not available from 1992 - 2000). Source: - HDFC Mutual Fund)

The flows may have been irregular, but they have been fairly consistent.  Even if we had just mimicked them, we would have made more money.

Let’s try to reason why FIIs are so bullish on India

• India offers significantly higher growth than world growth.
• Favorable demographics, rising affordability, low penetration of consumer goods, rich natural resources, large size are some of them.
• By 2020, India is expected to be 6^th or 7^th. Largest economy in the world.

 They have personified the quote “time in the market is more important than timing the market”.

It’s time we accept the fact that there’s certainty of returns from equities. The timing of return is however uncertain.

Peter Lynch had said –“I've found that when market’s going down and you buy funds wisely, at some point in the future, you will be happy. You won’t get there by reading “Now is the time to buy”. These things never go off that way”.