Vijay Kumar Gaba

 The benchmark Nifty 50 index has given almost no return in the past 12 months. Nifty Smallcap 100 Index is down over 13% and Nifty Midcap 100 index is down about 2.5% over the same period. Adjusted for dividends and inflation, the real returns would be worse. On a comparable basis, the benchmark S&P 500 index of US yielded a negative return of ~15%; Stoxx500 of benchmark index for Euro Area returned negative 12% and Hang Seng, benchmark for Hong Kong market, returned a negative yield of ~30% over the same period.

This is a popular set of statistics that is used by market participants like advisors, portfolio managers, and wealth managers etc., to advance arguments in support of their past performance and future prospects of investments made now.

Investors use this set of statistics in a variety of ways. For example—

·         Investors following a relative return strategy may find comfort in the fact that their portfolios have performed better than the benchmark indices, though they have lost money or earned a negative return on their investments.

·         Investors who are invested for a long term, may argue that Nifty 50 3yr CAGR is still 15.5%, which is a decent real return of over 10% p.a., accounting for inflation and dividends.

·         Some investors may draw comfort from relative outperformance of Indian benchmark indices, as compared to the global peers; even though their own portfolios have yielded negative returns.

In my view, however, this could be a serious mistake most of the investors might be making. The relative return argument (or “strategy” if you prefer to use this jargon) serves no purpose for those investors who are depending on their portfolio of financial investments to meet key goals of their life, e.g., financial freedom and retirement planning etc. To the contrary, this argument could actually lead them to a false sense of security and comfort; whereas their primary objective of investment might be getting defeated.

The investors whose investment objective involves any one or more of the following ought to prefer an absolute return strategy, instead of a relative return argument. For their investment objective would invariably involve a defined cash flow over a definite period of time.

1.         Retirement planning – regular income to supplement the loss of salary/wages.

2.         Goal based investment, e.g., buying a house, children education expense.

3.         Financial freedom - assured minimum income to allow

Such investors should ignore the noise and resist excitement in their investment endeavors. Their investment strategy must focus on making a reasonable rate of absolute return over the “defined” period of time. Beating the benchmark index should be the least of their concerns.

However, the investors whose investment objective is primarily wealth preservation and/or reasonable growth; and regular cash flows from investment are not required to sustain (or improve) their lifestyle may accept a relative return argument; for historically the benchmark indices have been able to yield decent positive real return. These investors can afford to bear intermittent volatility since they do not need regular cash flows or lump sum redemptions at defined intervals.

 Over the last weekend, I attended a lecture on the doctrine of Karma, read couple of books on philosophy of investment, and observed zillion of nuggets of investment advice, apparently written by highly successful investors and/or advisors, on my social media timelines. Admittedly, all this was quite befuddling for me. Everything, I read or heard caused an overflow of conflicting thoughts and emotions. I spent the entire Republic Day holiday in extricating the entangled thoughts. I am not sure, if I attained any degree of success in my endeavour. Nonetheless, I understood the following very clearly–

(i)    Like any other Karma, the process of investing in financial products is personal to every individual. No two individuals will have exactly same investment plan – strategy, goals, process and outcome. The similarities between religion (morality, ethics etc.) and investment end here.

(ii)   Investment advisory issued (free) to common public is mostly a redundant function, inasmuch as it does not take into consideration the individual circumstances of an investor.

(iii)  Financial investment is a tiny subset of the one’s overall life. The life path one sets for himself does impact the investment plan. But vice versa may not be true. If investment plan (strategy, goals, process and likely outcome) begins to drive the life (cart before the horse), it is a huge problem.

Doctrine of Karma

Karma is perhaps the most popular word of Indian origin that has been incorporated in global lexicon. This is despite the fact that the doctrine of Karma is intrinsic to Indian belief system of rebirth and salvation and does not fit the practice of Abrahamic religions (Islam, Christianity and Judaism) and most other traditional religious belief system across Africa and Latin America.

By most simplistic definition, Karma means Acts performed by a living being. The doctrine of Karma says, insofar a living being is engaged in the eternal cycle of rebirth, the condition of present and future lives is determined by his/her Karma of past and present life.

While performance (or otherwise) of Karma is completely individual, the common goal of all Karma, performed by all living beings is to obtain release (salvation or Moksha) from this eternal cycle of rebirth. Each one has to accumulate enough good Karma that will be sufficient to secure a release from this cycle of rebirth.

The doctrine of Karma is thus motivation to live a moral & ethical life. This also explains the pain, suffering and existence of evil.

Investment advisory

Investment advisory is function of formulating a financial plan for a person or group of persons. This involves, evaluating the financial conditions of a person, setting investment gaols, making an investment strategy to achieve these goals, and assisting the person(s) in executing the plan.

Investment advice thus is very personal service. It is less likely that an investment advice shall be equally relevant for two persons or group of persons. It is therefore very important that while accepting a “common” investment advice, one needs to be extremely careful. Let me explain this by way of an example:

A “common” investment advice is that by investing in an Index Fund (passive investment), one can earn a steady return over a much longer period of time. Nifty has given CAGR of ~9% over past 30years. These 30yrs have seen extreme volatility, many wars, multiple scams, global crisis, pandemic, many droughts, extreme political instability (and stability), etc. Even in USD terms, CAGR of Nifty over past 30yrs is close to 5%. This sounds very good.

Now consider the following:

(a)   Nifty witnessed 18 corrections of over 10% in these 30years. These corrections ranged 10 to 60% from the peak level before correction. (See the chart from latest CLSA report below)

If a person had the investment plan period of less than 30yrs, there was a decent chance that he would have made much lower returns. For example, If someone invested in Index ETF in April 1992 (Nifty 1281) and redeemed his investment in September 2001 (Nifty 854), he would have lost over 30% on an nine year investment. Similarly, investment made in Nifty ETF in January 2008 (Nifty 6279) would have yielded just 1.5% CAGR if redeemed in March 2020, a good 12years later.

I appreciate that taking peak and bottom level of indices to state my point may not be appropriate. But it does not change the point. Investment in financial products is not like Karma. One wants to see the outcome of investments over a finite period, usually not as long as 30years.

We do not invest in stocks, with the idea that the profits will come, if not in this birth, may be in next birth; May be I would die before enjoying the fruits of my investment, but my grandchildren will certainly enjoy it. This may be an eventuality. But this is usually not the plan.

Therefore, while investing in an index fund, I must be mindful that only that part of my investment should go in Nifty ETF which I would not be forced to redeem in case of an emergency or contingency, especially if this emergency happens to be a macroeconomic event that might cause a sharp temporary fall in equity prices.

(b)   One must realize that protecting the savings from inflation is one of the primary goals of financial investments. In past 30years (and even in past 10years), India’s average consumer price inflation rate has been above 7%. Adjusted for this Nifty 30yrs CAGR may be under 2%. Does not look glamorous by any imagination!

The short point is that “common” (free) investment advice might be applying the doctrine of Karma to financial investment also. It may be assuming equity investment to be a perpetual endeavour, lasting for generations. Unfortunately, it is not the situation in most cases. People usually invest in stocks for generating some additional income (dividend plus capital gains) in foreseeable future. Their investment plan needs to be prepared accordingly.

I received lots of comments on the yesterday’s post (Investing lessons from down under). Most commentators agreed with my view that a good portfolio must be a balance of consistent compounders and emerging businesses; whereas few expressed strong disagreement. Unsurprisingly, amongst those disagreeing were both types of investors – those who prefer to stick with consistent performers; and those who prefer emerging businesses with a potential of abnormal returns in short to mid-term.

I find myself totally disinclined to argue with any of the commentators, since I strongly believe that investment is essentially a personal endeavour. Each investor will have a different strategy based on his/her personal circumstances, requirements, and aptitude. The widely followed investment strategies are basically templates. Individual investors customize these templates to make an investment strategy most suitable for them.

I however would like to discuss one thing that stuck me hard while reading these comments. I found that most commentators (I believe they all are investors) are not sure about the primary goal of financial investments. Upon enquiry, I received the following answers:

·         Wealth creation (40%)

·         Become rich (25%)

·         Higher profit (25%)

·         Others (10%)

I wonder if these are correct definitions. What I have read in management books is that “goal” of a financial plan must be quantifiable and definite to the extent possible.

·         “Wealth” itself is a vague term. Various people define it in different ways. There are many who even refuse to consider “wealth” as a pure financial term. “Wealth Creation” is even more vague.

·         “Become rich” is even more vague. “Richness” in financial terms, is purely a relative term. It may have entirely different connotation for persons living in Mumbai and Madhubani. This goal is certainly not quantifiable.

·         “Higher Profit” is also a relative term and could be infinite. It could mean higher than alternative avenues of deploying savings. It could also mean higher rate of return than a targeted person or institution.

In my view, the core of investment strategy is to define a definite quantitative goal. Some examples of these goals are as follows:

(i)         Preservation of capital in real terms (inflation adjusted)

(ii)        Return on investment of 10% more than the nominal GDP growth

(iii)       Return of 5% in USD term, since I am saving for my child’s US education