19 August, 2010

Investment does not always work like in textbooks

Wisdom, they say, comes out of experience. But is the same wisdom applicable to you as well? Sometimes, it may. But there is no thumb rule that it will always do. For instance, John Bogle’s famous book ‘Common Sense on Mutual Funds’ has argued that over time, index funds will always outperform actively-managed mutual funds. And while this can work consistently in a more developed market such as the US, results in the Indian market may not be that convincing
If we look at investment wisdom as handed down by the gurus, there is a gap between what one could expect and what actually happens.
Invest for keeps - The Sage of Omaha – Warren Buffett, is a great believer of investing for the long-term. In fact, he says, if it is a really good investment and works, he advocates investment for ever. He has quoted Coca-Cola as an example, where he has kept his investments for decades.
This does not always work. Many companies, which are in a commanding position at one point, do not remain there forever. Changes like technological developments can undermine a company’s market position ( Kodak, Xerox ), may reach the end of the product cycle and mature.
There are companies that are able to emerge winners and there are those who fall by the wayside. NOCIL, ORKAY, Nirlon, Dunlop were bluechips of yester years; but fell by the wayside for a number of reasons. So, if one were invested in them and just continued to hold, it would have resulted in value erosion. What Buffett said will work in some cases, not universally. You will constantly need to keep evaluating, if such stocks should have a place in your portfolio.
Index investing is the best bet - This is a truism that has worked only partially in India. This has been substantially true in the US. Even factoring the higher expenses, actively managed funds do offer higher returns over index. For instance, the average returns of all large-cap diversified beat the index, in one, two, three-year performances. Only five-year performance, the index had done better than the average performance of all the large-cap diversified funds. Now, ten year returns for Sensex & NIFTY are 15.79% & 15.21% respectivey. The average for all diversified equity funds is 22.03%. If you look at the top performers like HDFC Top 200 Fund, Reliance Vision Fund, they are all at 30%. That’s almost double of what the index offers!
What index investing, however, does for the investors here is to do away with the fund picking acumen of the fund manager and lower the cost of managing such a fund. But should it be the only part of your portfolio, I doubt it.
Timing it to a nicety – How we wish, we entered and exited the market, always at the right time. And technical chartists would have us do just that. Every day, television channels and newspapers have chartists telling investors ‘buy, sell or hold’. The only problem: Future is projected on the basis of past data. True, it will work sometimes. But not always. For retail investors, it’s a completely unreliable tool.
No wonder, even the Securities and Exchange Board of India asks mutual funds to say – Past performance is not a reflection of future performance – in their advertisements.
On a lighter note, as Fred Schwed writes in his investment classic ‘Where are the Customer’s Yachts?’ – “In our moments of sober thought we all realise that booms are bad things, not good. But nearly all of us have a secret hankering for another one. Another little orgy wouldn't do us any harm, would it? This is quite human, because in the last boom we acted so silly. If we are old enough, we probably acted silly in the last three. We either got in too late, or out too late, or both. But now that we are experienced, just give us one more shot at a good reliable, runaway boom.” Only problem – there is nothing called a good, runaway yet reliable boom that one can enter and exit, exactly at the right time.
Value investing principle – Another commonly-touted idea. The problem is in the term ‘Value’ itself. Value lies in the eyes of the beholder. At the height of the dot-com boom, companies with price-earnings (P/E) multiples of even 200, found takers. So any stock that would have quoted at 75 P/E would have been seen as a true value proposition. It is also very dependent on the industry in which the company operates, as well as their growth potential. Also, value could be derived from replacement value (as popularised by Harshad Mehta ), Book value to price principle, price-earning to growth ratio etc. Value can also be a by product of softer aspects like brand salience (Apple, Sony), quality of management (GE, HUL), innovation (Apple, 3M). That’s precisely why a lay investor is not able to get it right.
Catch them young and watch them grow – We all want to invest in the next Reliance Industries or Infosys, right? The place to look for are the sunrise sectors and good companies there. But identifying the future sunrise sector is fraught with danger. Does bio-informatics qualify for a sunrise sector? It probably does, because it is an emerging area. So does, clean energy technologies, nano technology, contract research and manufacturing in pharma, genetic engineering etc. But, even companies in far more low tech areas may be sunrise sectors too - agriculture and agro-based industries, water based industries, environment management based industries etc. Now, identifying the sectors of the future correctly, is a challenge by itself. Then putting money in the right company is even more of a challenge – as many of them would be unlisted companies and too much information about them would not be available in public domain. That is why, these companies have a fair ownership by venture capitalists, private equity investors and others, who are savvy and who will be able to invest in early stages. There may be very few in public domain and they could be expensive.
Hence, a lot of what the analysts and gurus say, cannot that easily be replicated by a regular investor. While, there is no denying that gurus have been able to do it, the normal investor still finds them a challenge. Remember, there is an important difference: Investing is a full-time profession for gurus and analysts, it’s not the same for you. For you, there needs to be an investing strategy that is consistent with your risk-appetite, time horizon and so on. Keep it simple.

Published in Business Standard on 8 August, 2010

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