In 1986 I presented my findings as a Ph.D. student about equity returns since 1964. The thesis was that if the investment was in a portfolio of stocks, and if that portfolio was reviewed to keep winners and throw out losers, the returns were high enough to beat inflation. It is in implementing this simple principle, amidst the din of everyday events at the markets, that many investors get lost.
The most striking illustration of the miracles of equity investing can be found in the list of the wealthiest people in the world. The wealthiest today are mostly equity investors. They set up businesses that add so much value to the world, that the equity shares they hold as promoters make them rich beyond imagination. To be a blue-blooded equity investor, one should set up a business that succeeds dramatically. For those of us who seek salaried jobs, equity investing is the route to participating in successful businesses. We do not have to run them, but we can fund them and enjoy the success.
The publicity that success stories receive makes many think that equity investing is easy. Since 1986 to date, the most commonly asked question when I talk about equity investing is: Tell us which is the next business that will perform magically, so we can invest and turn rich. This trivialization attracts punters and scares off the cautious. Equity investing provides magical returns and carries severe risk, only because not all businesses can succeed–even if they were run by the best managers. There is no formula for sure-shot success. We can follow the gurus, hang on to the coat-tail of Warren Buffet, venerate fund managers, stay tuned to channels that belt out names all day, and still make no money.
This is why the rule I mentioned at the start: a diversified portfolio of well-known stocks spread across multiple sectors. Buying a large-cap index such as the Nifty or Sensex is adequate. Exchange traded funds (ETFs) enable this at a low cost.
The benefits of an index ETF are many. It is made up of large and well-known businesses. It is well diversified. It is revised to drop off stocks that are not doing well. It is created and maintained independently by stock exchanges. It is low cost and easy to buy with a simple demand account. Ideally, a large-cap index ETF should be the choice for the first time equity investor and promoted as a product that households should have.
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But the government comes up with ideas that are tough to justify. The EPFO has decided to invest in the index fund of PSU fund managers. Three problems here: First, index funds can have tracking error or fail to track the index as closely as mandated; Second, there is no rationale to believe that PSU funds are better than others, save for the suspicion about everything “private“; Third, the EPFO needs an investment committee that chooses based on accepted prudential norms. It is risky for investment choices to be made based on prejudices.
The NPS has tried to go one step ahead: A committee that looked into the product has proposed that investments need not to be restricted to index funds, but can extend to other funds and stocks. This is not all. The government proposes to “encourage“ investment in PSU stocks by asking common investors to buy “cheaply priced“ IPOs. The Rajiv Gandhi Equity Saving Scheme holds a dangerous tax sop for a first-time equity investor in specific stocks (mostly PSU). If the idea is to involve the common investor, the product being recommended should pass the fiduciary test of prudence.
The important message about equity investing that should reach common investors is that it is not easy. The idea that a lot of money can be made by doing next to nothing should be debunked. What we need is the understanding that investing in a bunch of proven businesses may not result in windfall profits, but is the most sensible way to participate in equity. Since there is no commission to sell ETFs, this category receives no sales pitch. Then there are pundits who poke holes about the index components to show how easy it is to beat it. An ETF is a good default base to begin equity investing. Everything else including the star fund manager, the newest IPO, the next best small stock, and the wonder-kid entrepreneur can be added as we go. If the government is taking on the job of promoting equity investing, the product it recommends should be prudent, diversified, proven, and unbiased. PSU IPOs and PSU funds, do not make the cut.
Source: TOI 13th July’2015