“Investors wrongly
base their investments on past returns”
Markets
may do well even while there are challenges and by the time all challenges are
resolved, there may be little juice left.
When a fund house manages to multiply your money
nine-fold in 10 years, it draws in even the most sceptical of investors. That is
what HDFC Mutual Fund has done. The fund has been remarkably consistent too, a
sign of the level-headedness with which Prashant Jain, the fund’s Executive
Director and Chief Investment Officer, approaches the often whimsical business
of stock market investing.
Is the fund’s past a hard act to live up to? And
are high stock returns in India India
Let me first clarify that there is no quant-based
model at work — in fact, I have never used one. My approach to investments has
been pretty simple. Buy sustainable businesses that are managed by good
managers, at or below fair values, maintain reasonable diversification and have
patience. I think it is also fair to say that while the performance of HDFC Top
200 over medium to long periods has generally been good, there have been short
periods when the performance was average. In 2007, for example, when the rally
was mainly led by stocks in real estate, NBFCs and power utilities, the fund
did not do well. The fund stayed away from these sectors as, in our opinion,
these stocks had issues of either quality or valuation or both. Whereas this
hurt short-term performance, it helped performance when the markets finally
corrected the excesses.
A key feature of the investment strategy has been
to invest in good quality, sustainable businesses that are available at
reasonable valuations. It is essential to maintain this discipline in tough
times and not to succumb to pressure, in order to control risk. Risk control is
as important to wealth creation as is generating returns. An investor who
generates moderate returns fairly consistently with limited downside risk is
likely to do better when compared with another investor who sometimes achieves
spectacular returns but makes occasional considerable losses. A 16 per cent
return over a decade is more than 20 per cent returns over nine years followed
by a 15 per cent loss in the tenth!
Investor faith in equities is at a low ebb today,
with the Sensex return over five years at barely 3 per cent, while gold has
managed 25 per cent. Can past returns be replicated over the next 10 years?
Even 10 years ago, one had neither expected nor
targeted 30 per cent returns. It is, therefore, hard to say how the next 10
years will be, but the guiding principles should stay the same. It needs to be
noted that a significant portion of the total returns of a fund over long
periods comes from market itself. Despite the pessimism in the markets and the
challenges in the economy, in my opinion, unless we really mismanage, the
economy should, in the current decade, grow faster than in the last decade.
The markets should also, over the medium to long
term, do well, given the prevailing below average price-earnings (PE) multiples
and the likely fall in interest rates. Thus, in addition to earnings growth,
returns should be aided by expansion in PE multiples. Another source of returns
for an actively managed fund is the out-performance. HDFC Top 200 has
outperformed the benchmark by a handsome margin over long periods. We will
endeavour to continue this. But most out-performance is achieved due to market
excesses and is, therefore, typically lumpy.
HDFC Top 200 and HDFC Equity are today among the biggest
equity funds in the industry, each managing over Rs 10,000 crore in assets. At
what point does size become an impediment to performance?.It is true that these
funds are larger than other funds. But the size of these funds and in fact, of
all mutual funds put together, is small compared with the Indian markets. The
largest fund is just about 0.2 per cent of the market capitalisation. There is
thus little risk of being crowded out.Fund sizes are not close to a point where
they start impacting performance, particularly against the benchmarks, in my
opinion. I did a small study of performance of funds larger than Rs 1,500 crore
and smaller than Rs 1,500 crore against their benchmarks.
The proportion of out-performing funds in both
categories is nearly the same. Over longer periods, larger funds have, in fact,
fared better. We often cite HDFC funds as an illustration of how well active
investing works in India
The market has rallied 20 per cent this year. There
are worries that this is not backed by fundamentals. Is this the time for
retail investors to buy stocks or should they take profits where they are
available?. Despite the up-move in the markets, PEs are below long-term
averages and interest rates are likely to fall over time. In my view, over
time, there is room for markets to do well and apart from earnings growth there
is room for multiples to expand too. I am not saying that there are no
challenges or that everything is great. However, please remember that markets
know as much as you and I. Markets discount both bad and good news fairly
quickly. Thus, markets may do well even while there are challenges and by the
time all challenges are resolved, there may be little juice left in the
markets.
Past experience suggests that PEs tend to move
10-12 times at the lower end and 20-25 times at the upper end. The journey from
bottom to peak and back takes considerable time and investor patience at lower
PEs is well rewarded over time. Every market cycle usually has new lessons for
investors. What should we learn from the most recent one?. In the 20 years that
I have been with the markets, I have experienced three major cycles and in each
one of these a vast majority of investors have mistimed their investments. This
is disturbing but unfortunately true.
Consider the accompanying data. As the Sensex went
up from 3000 levels in 2003 to a peak of above 21000 in January 2008 before
ending close to 15600 levels in March 2008, net sales of equity mutual funds
increased from just Rs 118 crore in 2002-03 to Rs 53,000 crore in 2007-08.
Since then, in down markets and at lower PE multiples over the years from 2009
to 2012, equity funds have seen outflows of Rs 6,000 crore. In simple terms,
when PEs were high, more than Rs 50,000 crore worth of equity funds were
purchased in one year in FY08 and when PEs were lower, nearly Rs 6,000 crore
worth of equity funds were sold by investors over four years.
This is so because investors wrongly base their
investments on past returns and on news flow and not on PE multiples. Investors
should simply practise low PE investing. Low PEs are typically available only
when the news flow is bad, when market sentiment is weak and when the markets
have not been doing well. Presently, though the markets are up 20 per cent, PEs
are below long-term averages. Further, interest rates are likely to move lower.
Investors, in my opinion, should maintain or increase allocation to equities in
line with their risk appetite and with a long-term view. Going by the lack of flows in equity funds for last
several quarters and in fact some redemptions, history may repeat itself. As
long as this behaviour of investing disproportionately large amounts after
strong past returns and investing close to nothing after poor market returns
continues, in my opinion, investors will continue to gain less from equities
and several may continue to feel dissatisfied.
As Einstein said, “Insanity is doing the same
thing, over and over again, but expecting different results.”
http://www.thehindubusinessline.com/features/investment-world/investors-wrongly-base-their-investments-on-past-returns/article4130573.ece?homepage=true&ref=wl_home
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