The benchmark Nifty 50 crossed the 16000 mark
for the first time this week. Predictably, the moment was celebrated by media
and “market influencers” with gaiety and fervor that is usually shown at
Nifty50 crossing every subsequent thousand (K) mark. The fact that from 10k to
11k - it is a 10% rise; whereas from 15K to 16K it is just 6.67% rise, is
usually disregarded in celebrations and recounting of the journey from one ‘K’
mark to the next “K’ mark.
It is also mostly ignored that Nifty, like any
other statistical number, is meaningless in isolation. It must be juxtaposed
with some “other” statistical number to derive any inference. The selection of
this “other” number, however, usually depends upon what the data user wants to
conclude. If the user wants to feel good about the current Nifty number, a
comparison with an inferior set of statistics is preferred (e.g., Nifty has
performed better than gold over past decade); whereas if the user wants to show
the current Nifty number in a poor light, a superior set of statistics may be
chosen to compare (e.g., Dhaka DSE30 has outperformed Nifty50 by 150% over past
one month).
However, if the idea is just to celebrate, like
drunk dancing in the wedding of a distant relative, a statistical number may be
used in isolation.
In past 25years, Nifty return pattern has been quite erratic.
From one ‘K’ to the next ‘K’ view point, there have been three instances of
very fast journeys (2006-08; 2017-18 and 2020-2021); and there have been two
long journeys (1993-2003; 2008-2015).
To make
the data feel better - overall, in past 25yrs (September 1996 to August 2021)
Nifty has yielded a return of ~12.5% CAGR. In this period average inflation has
been close 7.5%. So, it is a decent 5% inflation adjusted return over past
25yrs.
But this data may actually mean little for an
individual investor, considering that-
·
The average vintage of
investors in Indian market may be less than 15years;
·
There have been four massive
draw down of over 25% each in these 25yrs, where many investors may have given
up with little or even negative returns;
·
The point to point return in
Nifty from any randomly selected date means little for individual investors. It
is the actual return that matters;
·
Anecdotal evidence suggests
that maximum investors take or increase their equity exposure in the rising
market only. The largest inflows by household investors are usually seen during
the last phase of an up move. Also, the exposure of household investors to
Nifty ETFs is not significant, so change in Nifty value may not actually
reflect the return earned by an average household investor; and
·
Most household investors prefer
to invest in mid and small cap stocks with ‘multibagger’ return potential. The
rate of failure in this segment is extremely high. There is decent chance that
most household investors have underperformed the Nifty returns over this
period.
For a majority of the household investors,
therefore, celebrating a milestone in the 27yrs journey of Nifty is mostly like
drunk dancing in the wedding of a distant relative. It gives a momentary high,
dirty cloths and a painful hangover, the next morning.
It may be
argued that since Nifty is on a journey that shall continue ad infinitum, every
milestone covered in the course of this journey deserves celebration. I would
tend to agree to this argument, provided this opportunity is used to stop for a
while, reflect back, review the journey so far and make amends, if any needed,
in the plans for the onward journey.
To create a false sense of feel good factor amongst investors,
the commentators are over emphasizing on the returns from the early Pandemic
low of below 8000 recorded in March 2020. A more than 100% rise in less than 17
months gives an illusion of the potential extraordinary returns in the adverse
economic conditions also. This illusion has in fact lured an entire new crop of
investors and traders in to equity markets.
The Good:
Increased household participation in equity investing is a good sign for
everyone – corporates; investors; market participants and the government. The
channeling of household saving to productive sector, against negative real
return yielding deposits or unproductive assets like gold is always welcome.
Another good thing to note about Indian equities is that Nifty has outperformed the global peers in INR as well as USD terms during past 12 months.
The Bad: However if we accept
that (a) most of the household investors were already fully invested in March
2020; (b) the new investors have not made meaningful allocation to equity and
are just testing waters; and (c) A large number of investors have withdrawn
money from mutual funds and other professionally managed investment scheme and
invested directly in equity (as indicated by the data of larger retail
participation in daily trading activity and persistent outflow from mutual
funds over past 15 months) .then we could easily assume that not many investors
have made 100% return from the lows of March 2020, even though most of those
who stayed invested through panic would have been saved from losses and made
decent return on their investments. Also it would be reasonable to assume that
the current portfolios of many investors are dominated by stocks with
relatively poor quality of balance sheet, earnings profile and sustainability.
The Ugly: The ugly part is that
the small and midcap stocks have massively outperformed the benchmark since
Pandemic lows of March 2020. Not all small and midcap stocks are poor quality.
But a large part of these stocks are either poor quality or represent highly
cyclical businesses. This kind of divergent performance has usually ended
disastrously for investors. As of now, there is no reason to believe it will be
different this time.
Nifty returns vs Investment returns
We can put the Nifty returns in perspective by
taking example of these two household investors ‘A’ and “B”.
Investor A is an ideal investor. He is 40yrs
old; started investing in 2006 (Nifty 3966) when he joined his first job; has a
portfolio that is mostly aligned to Nifty (mostly large cap funds and some
direct equity); invests his surplus savings (Rs5,00,000/year) at the end of
every year; and has not sold anything in 15years.
After 3 full market cycles, this investor would
have earned a return of 11.55% CAGR as of today. The rate of change in Nifty in
this period is 10.13% CAGR.
Investor B is also a household investor, 40yrs
old, started investing in 2006 (Nifty 3966) when he joined his first job; has a
portfolio that is mostly aligned to Nifty (mostly large cap funds and some
direct equity); invests his surplus savings (Rs5,00,000/year) at the end of
every year; but is not as disciplined and confident as the Investor ‘A’. He
easily gets influenced by the forces of greed and fear – sells during panic and
buys in euphoria.
He started in December 2006 and exited in
December 2008 (post Lehman); redeployed the sale proceeds and new savings in
December 2010 (Post QE) and exited in December 2016 (post Demonetization);
again redeployed in December 2017, did not get panicked in March 2020, and is
still invested. This investor would have earned 7.9% CAGR on his investment,
though his net principal amount invested is same as Investor ‘A’. (For the sake
of simplicity, dividends and cost of investments have been ignored in these
calculations)
Nifty returns: A realistic expectation
The jargons like long term and short term are
frequently used by the market participants, without providing any context to
it. This jargon may have entirely different connotations for different set of
investors. For taxation purposes, it refers to less than 12 months (Short term)
and more than 12 months (long term). For risk capital investors (VC, PE etc.)
this may relate to life cycle of a business; and for stock traders it may a
technical swing lasting between few weeks to few months. Also, for a portfolio
(diversified mutual fund etc.) investor this could be different than the
investor holding a direct stock.
To
understand it more clearly consider this – for an anthropologist long term is
many million years; for a geologist long term is many thousand years; for a
historian long term may be many centuries; and for a semiconductor chip
designer long term may be a nanosecond.
If for the sake of simplicity, we assume long
term to mean 5 calendar years, Nifty returns (rolling 5yr CAGR) were very
volatile for first 20years (1995-2015). Since then the volatility has reduced
materially, with this number stabilizing close to +/- 12% range. This is
despite poor economic growth and large drawdowns on demonetization, GST, Covid
etc.
11-12% CAGR is what a reasonable investor must be striving to
achieve. The target may be lowered further if inflation moderates and interest
rates ease further.
