Will your investment strategy change post May 16? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Will your investment strategy change post May 16? 

A  A  A
In this issue:
» India's healthy forex reserves.
» Americans seem ill-prepared for the coming crisis.
» Frequent churning & chasing fads: Keys reasons for underperformance.
» Retail investors continue to stay away?
» ...and more!

How many times have you hoped for a market correction in the recent past? - is a question we would like to ask you, the long term investor. This hope would be with the assumption that you are willing to invest in a bunch of stocks that you have shortlisted, but those which may not seem cheap now. In hindsight, the months of August and September 2013 seemed to have been good times to invest. But then, with so much pessimism around, one cannot be blamed for waiting for further correction. But now, with the markets having moved up substantially, the hope for a correction has only increased.

Not to mention that the feeling of having missed out on the current rally seems to only get worse as stocks continue to surge, touching new highs day after another.

The election season this year has played an important role in the market run up. Plus, with developments such as the IMF's forecast of India's growth rates accelerating from hereon has added to the optimism. With these developments, valuations of stocks are inching upwards, hovering around the not so comfortable zones.

As pointed out by the author in an article published in the Business Standard, these developments seem to have put even long term investors in a dilemma. The author states if the NDA does come into power, the current rally could continue. And if this would not be the case, then the markets could possibly crash.

We would like to point out here that in our recent initiative - the Equitymaster Club, discussions on the elections this year and their possible effect on the stock markets is one section that has been quite active lately.

The author of the article is of the view that the present time is one that is making a long term investor nervous. Why? Because he cannot help but think about the possible surge in markets after a favourable outcome in the elections; but the same time, at the back of his mind, he would be thinking about the possibility of the occurrence not happening.

The suggested action steps provided for such investors would be to ignore the political situation and stick with the process of bottom up investing - something which we agree with. Or, he could, invest in an SIP scheme and take advantage - or be disadvantaged - of the market volatility in the coming two months. But then, this would come at the cost of opportunity that he would lose out by investing fully prior to the outcome - is a thought that would cross one's mind - thereby adding to the confusion and ergo, the nervousness.

In short, long term investors are in a dilemma, hints the author, and the current situation would be best tackled by taking a stand and sticking with it.

Business dailies in recent times have been writing about how the stock markets reacted to earlier election result outcomes. But this time, the expectations of surges in stocks - post the election results - vary from anywhere between 5% and 20%. Substantial gains in a matter of a day, aren't they?

With all of this happening, we cannot help but think that these developments can make long terms investors to want to participate in the current rally. But, taking a step back and viewing the whole episode from a broad perspective is something we suggest.

Investor participation in stocks should not be influenced by political developments and the reason for investing into the same would be sentiment driven. And market rallies driven by sentiments rarely last! Not to mention that it is anyone's guess how stocks will perform post the results are declared as it seems that the positives are taken into account.

A few months down the line, post the election results, the focus would once again get back to the true determinants of stock prices, earnings growth and earnings quality. These should be the areas of focus of long term investors.

What will be your strategy till May 16th, the day the election results get announced? Let us know in the Equitymaster Club or share your comments below.

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01:40  Chart of the day
It was barely a year ago that the condition of the India rupee was 'fit to be in ICU', as declared by the media. Global media called the rupee one of the world's "fragile five" currencies. This was as India struggled with a chronic current account deficit that was eating into its limited forex reserves. Between now and then, India's macroeconomic fundamentals have not changed dramatically. However, the status of the rupee has certainly improved. This is all thanks to the consistent flow of FII money in anticipation of a change in government. The curb on gold imports and Indian banks being allowed to raise dollar deposits also helped.

India's forex reserves: Nothing to worry about?

All put together, India's foreign exchange reserves stood a tad over US$ 303 bn at the end of March 2014. This is about 10% higher on YoY basis. The only fiscal years that ended with higher reserves were the years ending March 2008 and March 2011. Having said that, India's current forex reserve covers just 8 months of imports. And as per Wall Street Journal, most economists believe that the RBI should stock up more dollars. Especially in the event of unwinding of the QE a stronger forex cover can make India less vulnerable.

If it's difficult for even experts to grasp certain phenomena, one cannot expect the ignorant masses to do any better. The phenomena we are referring to is an understanding about what's actually going on in the US economy currently. Indeed, there are so many of the so called experts that believe that the US economy has turned a corner and hence, it's going to be mostly hunky-dory from here on. Nothing can be further from the truth though. If one tries to dig deeper and makes an effort to understand the real cause behind the current recovery, one would know that the whole thing is nothing more than an illusion. By keeping interest rates at near zero levels and by printing unprecedented amounts of money, the US policymakers want to give the impression that the US economy is on the turnaround path. However, it should be noted that none of the issues that caused the previous crisis have been addressed. As a matter of fact, things have only gotten worse. Therefore, we won't be surprised if we witness a crisis much bigger than what took place in 2008. The sad part is yet to come though.

As highlighted by a finance portal, most Americans seem ill-prepared for the coming crisis. It highlights how an astounding 60% of people in a survey don't even have 3 months' emergency funds to cover expenses if income stops coming in. What more, 40% said they can't come up with even US$ 2,000 if unexpected need arose. Clearly, they seem to be having too much faith in the US Government and its system. And this we believe may not be the right approach to take.

The Indian stock markets are scaling new peaks. The benchmark BSE-Sensex is just a couple of hundred points shy of the 23k mark. The revival in market sentiment has been on the back of expectations of strong leadership post the ongoing general elections.

But has the recent market rally benefitted retail investors? The answer seems to be no. In fact, as per an article in Economic Times, of the 2.1 crore demat accounts in India, about 1.1 crore are inactive. In other words, about half of the total demat account holders have exited stocks in the last few years and have zero holdings now. Moreover, most new accounts that were opened in 2013 were for investing in tax-free bonds and non-convertible debentures (NCD).

This is indeed a worrying trend. The problem is that retail investors shy away from investing when sentiment is poor and valuations are usually cheap. The tendency to follow the herd makes them enter the markets at the wrong time, when everything seems hunky dory and optimistic. This is indeed a big mistake and the perfect recipe to lose money. Rather, investors should buy solid companies when their available at a bargain price and not wait until it's too late.

How well has the mutual fund industry been performing in India? As per the data released by the Association of Mutual Funds of India (AMFI) and published in the Mint, 15 fund houses saw their AUM grow in FY13. Of these 15, 11 are among the 15 largest fund houses in India. Does that mean that big fund houses are performing well? And that smaller fund houses are struggling to grow? Some believe that there is ample scope for more fund houses to exist in the market and that the industry need not be dominated by only the 20 large fund houses. There are also opinions that some of the guidelines introduced by SEBI make it difficult for smaller fund houses to thrive. One is the elimination of entry loads. The other is the hike in net worth required to set up an asset management company. We believe that SEBI's responsibility is to protect the interests of the investors. So it does not make sense to criticize these two above mentioned guidelines simply because smaller fund houses are struggling. Indeed, the article has also stated that of the 15 smallest fund houses, 4 have managed to grow their AUM. What ultimately matters then is the track record of the mutual fund and whether the investing philosophy of the fund manager is sound. Once that is in place, such fund houses will continue to find takers, irrespective of them being big or small.

Time and again we have reiterated our long term investing focus as it enables portfolios to recover from short term volatility. And that this process reflects fundamental strengths of companies that one invests in; rather than market imperfections. As such, over longer periods, investors would be expected to earn handsome returns, right? Expectations would be that lengthening time horizon to 20 years, one could put fund managers to shame. But it's a shame that this does not seem to have been the case amongst American investors.

An analysis by JP Morgan Asset Management reveals that investor returns for a period of 20 years (1993-2012) has averaged to a paltry 2.3%. Returns from all asset classes over this 20 year period have outperformed returns of the average investor. If an individual is sufficiently diversified how is it possible that his returns are lower than what the asset class itself has generated?The answer to this question lies in these two terms - frequent churning and chasing fads. Frequent churning of portfolio increases transaction cost. And this hurts returns over the long term. Also, chasing fads in asset classes by tilting portfolios hurts returns. As an example, chasing an asset class when it performs well can lead to overexposure. Subsequently, when the asset corrects, the investor loses money.

The bottomline is that simply having a long time horizon is not sufficient. One should also have patience to hold on his stocks and not churn portfolio at will. Money is made by inactivity. Active investing only makes your broker rich.

In the meanwhile, the Indian stock markets continued to trade above the dotted line. At the time of writing, the benchmark BSE-Sensex was up by 47 points (+0.2%). Sectoral indices were trading mixed with stocks from the healthcare and IT spaces leading the losers, while those from the power and realty spaces were leading the pack of gainers. Barring Indonesia and Singapore, the major Asian stock markets were trading positive led by Hong Kong. Most of the European markets opened the day on a positive note.

04:55  Today's investing mantra
"Even the intelligent investor is likely to need considerable willpower to keep from following the crowd." - Benjamin Graham
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2 Responses to "Will your investment strategy change post May 16?"


Apr 11, 2014

Remain fully invested in momentum stocks. Do not trade too often.

Like (1)

Narayanan Sasi

Apr 10, 2014

Better to disinvest about 50% holding so that the gain or loss can be neutralised. Wait for the results and act accordingly.

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