Worried About Mediocre Returns from the Stock Markets? Here's My Solution...

Jun 25, 2018

Ankit Shah, Research analyst

On Friday, I'd accompanied a family member to Dadar railway station to help board a long-distance train. We wriggled through the heavily crowded platform no. 4 and made our way to the expected location of the coach.

We had arrived 20 minutes before time. With every passing minute, the crowd swelled on the narrow platform. The crowd was waiting for a train destined to Asangaon, a suburban station on the central line.

When this local train arrived, they pounced on the train like a barbaric mob, scrambling to find a few square inches of space to squeeze in their bodies. Before the train even halted on the station, the compartments were overflowing, with tonnes of people dangling at the door.

We felt intimidated by this sight.

Not that I haven't seen this before. I have... a thousand times over.

And yet this scene intimidates me. Because when I wear the hat of an analyst and imagine what the country's 'demographic dividend disaster' would look like, this is the image that comes to my mind - millions of young passengers jostling and squeezing to get into the country's economic locomotive and the alarming dearth of boggies. But I leave that subject for our big picture editor Vivek Kaul.

There's another scene of action that's getting more and more crowded and competitive - the Indian stock markets. And if you are serious about building long-term wealth, it's important you do a KYC before it's too late.

Know Your Competition (KYC)

Yes, dear reader, the game of investing is getting intensely competitive.

In an earlier editorial, I'd shown you how domestic investors are making a beeline to invest in Indian equities like never before.

They're all competing with you to grab a share of the wealth-creation opportunity in the Indian stock markets.

To be on top of the game, you ought to keep a check on them and shift your game to the higher gear.

Recently, I came across some compelling data in the SEBI's Handbook of Statistics on the Indian Securities Market 2017.

It showed the city-wise trend in assets under management (AUM) of mutual funds between 31 March 2015 and 31 Dec 2017.

City-Wise Asset Under Management of Mutual Funds (Rs crore)
Cities31-Mar-1531-Mar-1631-Mar-1731-Dec-17Change (31-March-15 to 31-Dec-17)
Mumbai456,665515,302747,187802,32576%
Delhi156,456170,563225,833267,13271%
Bangalore65,85074,595101,473119,58882%
Chennai49,59757,54081,270150,135203%
Kolkata50,37356,98480,21099,25897%
Pune41,69147,00167,49177,87787%
Ahmedabad38,45744,38652,03265,21770%
Hyderabad20,82123,45234,92445,086117%
Jaipur8,7609,34312,56315,26174%
Vadodara7,8768,91213,22217,128117%
Surat6,5786,83010,36213,199101%
Kanpur6,3586,9329,76612,19792%
Panaji5,8335,8267,9048,97454%
Lucknow5,9666,8669,61413,035118%
Chandigarh5,6046,5729,46712,762128%
Other Cities155,872191,719291,302407,489161%
Total1,082,7571,232,8241,754,6192,126,66596%
Data Source: SEBI

Here are five interesting patterns and insights that I identified in the table:

  1. Phenomenal Growth in Mutual Fund AUMs - Mutual fund AUM have nearly doubled in less than three years, growing at a compounded annual growth rate (CAGR) of 28%.
  2. Mumbai Rules the Roost - When it comes to mutual fund AUMs, Mumbai - the financial capital of India - alone accounts for 38% of the total AUM as on 31 December 2017.
  3. Top 8 Cities Command Lion's Share - Tier I cities, including Mumbai, Delhi, Hyderabad, Chennai, Bangalore, Pune, Ahmedabad, and Kolkata, reported a growth of 85% in AUM between 31 March 2015 and 31 December 2017. They accounted for 76% of total mutual fund AUM as on 31 December 2017 (in comparison to 81% as on 31 March 2015).
  4. Smaller Cities in High Gear - Tier II and III cities grew AUM by 147% during this period, much faster than the tier I cities. They, correspondingly, increased their share in total AUM from 19% as on 31 March 2015 to 24% on 31 December 2017. This is quite noteworthy. The smaller cities are rapidly lapping up sophisticated investment instruments like mutual funds as the traditional investment avenues like gold and real estate have been poor performers over the last few years.
  5. Demonetisation: The Big Catalyst - While total mutual fund AUM grew at 28% CAGR during the entire period, the highest year-on-year growth rate of 52% came between 31 March 2016 and 31 March 2017. What was special about this year? You must recall that the financial year 2016-17 was the year of Prime Minister Narendra Modi's demonetisation drive. As 99% of the cash in circulation found its way into the banking system post demonetisation, a portion of it found its way into the Indian financial markets. As such, demonetisation can be seen as a major catalyst that triggered the flood of domestic money into the stock markets.

Do you see the big picture here? Let me spell it out for you with the help of the most basic demand-supply equation of economics.

Let's say the stock markets offer us a product called "equity returns". What happens when there are more and more buyers vying for this product and the supply side remaining relatively tight?

You see, the supply of "equity returns" is a function of corporate earnings. And corporate earnings, in turn, are dependent on the overall growth in the economy.

Simply because there is a huge demand for "equity returns" doesn't result in its increased supply.

What happens when demand for a product increases rapidly but its supply is not able to match up? The premium on the product goes up. And correspondingly, buyers receive less value for their money.

This is precisely what has happened in the Indian stock markets. The valuation premiums on stocks have gone up because of the flood of domestic liquidity into the stock markets. But corporate earnings haven't grown as rapidly. As a result, the average market participant must compromise with average or below-average returns. That's basic economics.

But what makes the game of investing exciting is that the distribution of returns for all market participants is not uniform. Some manage to make average gains. Some just manage to safeguard their capital. Some even incur losses. And just a handful of investors make market-beating returns.

Now, it is this exclusive group of successful investors that really excites me. And they're the big winners because they don't do what everyone else is doing.

To beat your competition, you ought to do different things, and you ought to do them differently.

You need a rich pool of great investing ideas. You need to be on top of the big trends that are driving the stock markets. And most importantly, you need to inculcate the discipline, patience and emotional intelligence of successful investors.

At my premium newsletter Insider, I have made it my mission to guide an exclusive group of readers to outdo their competition in the stock markets.

At my disposal, I have access to a rich, diverse pool of investing and trading strategies from the Equitymaster research vault. And I'm at full liberty to cherry-pick the most profitable ideas from it.

Most recently, I've identified an attractive medium-term arbitrage opportunity which takes advantage of a lesser known rule to beat the big guys in the game of investing. The trade is still actionable and you can know all about it by signing up for my premium newsletter Insider.

Chart of the Day

I remember a time when market participants would look for cues about the direction of the market by closely following the buying and selling activity of foreign investors. Because at that time, foreign investors played a dominant role in the Indian markets.

But guess what, this has changed. The foreign investors are no more in the driver's seat in the Indian stock markets.

Look at today's chart...

The blue line plots the annual net equity investment by foreign investors, while the red line represents the net equity investments by mutual funds.

Foreign Investors No More in the Driver's Seat

Between FY01 and FY15, the blue line (foreign investors) is consistently above the red line (mutual funds), except in the financial year 2008-09 (FY09). That was the only year in the 15-year period when mutual funds were net buyers in the face of an exodus by foreign investors in the aftermath of the global financial crisis.

But the dominance of foreign investors has been challenged since FY16. The net investments by mutual funds have exceeded foreign investor inflows in two of the last three financial years.

This is the reason why markets have remains relatively buoyant despite the heavy selling by foreign investors in recent months. Had it not been for the steady domestic investor inflows, the markets would have been in a deep correction.

Happy Investing,

Ankit Shah
Ankit Shah (Research Analyst)
Editor, Equitymaster Insider

PS: On Friday, Kunal Thanvi wrote to you about his latest Smart Money Secrets stock recommendation. He will publish it today...in just a few hours! You can sign up for it here.

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1 Responses to "Worried About Mediocre Returns from the Stock Markets? Here's My Solution..."

S.K.LIMAYE

Jun 25, 2018

Ankit , you have not said anything about the ever increasing supply through IPOs ? Lots of investment opportunities were created through them.

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