Time and discipline are the key to successful investments

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By Vetri Subramaniam, Group President and Head of Equity at UTI Asset Management Company Limited

The Indian equity markets are witnessing a new trend – the emergence of domestic investors. Historically Indian investors have preferred Gold, Real estate and Fixed deposits. Equities either directly or through mutual funds and even fixed income mutual funds have not been a preferred choice. This is rather unfortunate as equity is the best asset class for wealth creation over the long term. Diversified equity mutual funds are an excellent way for investors to participate in the asset class and achieve their long term financial goals. Investors should take note that equities are inherently a volatile asset class. But using an SIP or STP,  investors can overcome the challenge posed by volatility.

The Indian equity market has done quite well this year with the Nifty 50 index up nearly 25% as of Diwali. In fact, over the 4 year period beginning August 2013 the Nifty 50 index has almost doubled in value and due to the strong performance by midcap stocks the Nifty 500 index has more than doubled. In August 2013, valuations were cheap – at a discount to the long term average. Today, they are at a significant premium to the long term average. This does make the current environment far more challenging. In equity markets when valuations are high, perceived risk is low and when valuations are low perceived risk is high. But if realized risk proves to be different from the perception then outcome will surprise- in both directions.  It can be argued that some part of the current elevated valuation reflects the lower interest rates. But the counter argument is that lower interest rates reflect likely lower inflation and lower growth expectations. Such an environment also makes for lower return expectations from equities. On the other hand if growth accelerates then so might inflation thereby pulling yields higher and that would be a drag on valuations.  In a nutshell, in the current environment investors must moderate their return expectations from equities; the recent 3-4 year performance is not the best benchmark for potential returns from equities.

Anecdotally, with most investors we find that equity allocations are very low and given that they are investing through SIP and STP they should stay the course with their investment plans. The discipline of an SIP when implemented over a long period is that investments are made at a valuation that is almost in line with the long term market average valuation. Further, we find that large inflows are now coming into balanced and asset allocation funds-these funds by design cushion the volatility inherent in equities. Investors focus on nominal interest rates, but they should actually consider real interest rates (nominal interest rates minus inflation) in their decision making and today fixed income mutual funds are also attractive given current inflation.

The Indian economy is on a good wicket with most macro indicators in the comfort zone. Recent weaknesses in data, we believe, are likely to be transient – reflecting the lagged effect of demonetization and also the implementation of GST. However, a significant acceleration in GDP growth will require an upturn in exports and also in the investment cycle. The investment cycle is an area of concern as capacity utilization levels are low and many company/bank balance sheets are under stress. There is no fiscal headroom and it would be best for India to stay on the path of fiscal consolidation rather than look for a short term fix via a fiscal boost.

Risks are always present and it would be foolish to ignore them. Abundant global liquidity has powered equities around the world and we have benefited from this trend as well. A significant reversal in liquidity will challenge existing growth and valuations assumptions. In India earnings growth has been muted over the past 4 years and the expectation is that this would revive next year. Continued lack of traction in earnings could cause patience to run out. However, if history is anything to go by, the risks that eventually cause the most damage are those that ‘we don’t know that we don’t know’. Valuations are not an exacting science ringing a precise bell at tops and bottoms but they do forewarn us to be prepared.

Our advice to investors would be to stay the course with gradual investments through a systematic route and to have a long term perspective. This will enable them to ride out a period of increased volatility. History indicates that well managed diversified portfolios of Indian equities have created wealth for Indian investors.

 

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