(This appears in today’s Deccan Chronicle- (http://epaper.deccanchronicle.com/articledetailpage.aspx?id=12426077)

(Most investors without the stomach for volatility get trapped each time the market takes a turn or toss. Investing is a journey with many twists and turns, especially when it comes to mid caps. Some take aways from the market)

The last few months have brought home the risks of investing in to direct equities. There are many stocks which have fallen from favour due to some governance issues or some controversies. Even the mutual fund managers have been caught in this mess. Whether it is DHFL or GRUH or Yes Bank or the many commodity stocks that have seen their best behind, there are many casualties that have eroded wealth.

The Big Indexes do not seem to indicate any panic. The markets seem to be holding their own However, if we go to the next levels, the scene is like a battlefield. There are so many casualties and a few fatalities also. Many people would have been tempted by the noise of the market and got in to the market in 2017 or 2018. From there most commodity sector and NBFC stocks have not gone anywhere and most have cracked hard. So if you bought just two shares and both lost 40%, you are sitting with 60% and unsure of what to do. Most likely, you will sit on it in the hope that price will come back.

On the other hand, a Mutual Fund would have a large enough breadth such that even if three or four stocks tank badly, the impact on the overall NAV would not be much. For instance, if 30% of the holdings crack by 50%, the overall impact is only 15%. Of course, when the bull is roaring, the MF will lag your exhilarating climb.

For those who cannot stomach these steep changes, the Mutual Fund route is better. Diversification may moderate the returns, but it will also fall less.

Most commodity stocks you bought would have been bought on the basis of the P&L account (earnings, earnings growth, P/E multiples etc) .  I have generally used the Balance Sheet measures to buy commodity stocks. Just because China has shut some capacities does not mean that commodity prices will keep going up forever or that additional supplies will not come. Sooner or later, supply overtakes demand and all players go in to  the red. Then some players go out and the balance of demand supply shifts.  And in this business there is not much differentiation. So best is to buy or sell shares on the basis of the ‘replacement’ value of the business. Thus, I use the trend in “Price to Book Value” to buy or sell in this sector. I do not know my wait time, buy when I buy close to the lower end (as evidenced by past trend) my downside risks are lower and upside risks are higher.

Similarly, most NBFC stocks went in to valuations that were driven by growth rather than value or ROE. The best in this sector cannot even earn an ROE that is one fourth of the best in the manufacturing sector. There are no entry barriers and growth is predicated on an endless availability of funding. And the ability of this industry to keep bad debts low. Scandals in one lead to fear in others. And we can see that mutual funds and insurance companies seem to be the biggest provider of funds to this sector. And every company seems to be comfortable with a large short term funding source (Commercial papers, one year papers etc) in the hope that it will always be rolled over. When a DHFL scares the market players, every one (except possibly the big and old established names) will not find money even at a price. This will lead to a chain reaction, call for government intervention and rescue operations. One glance at the secondary trades happening in the debt papers of these finance companies show indicative yields as high as 18% for some lesser known names. This clearly shows that most are having to slow down their fresh disbursements and use that to repay debt. Thus, earnings disappointments will probably send the prices of the shares lower.

I still hold that Equities as an asset class get the best returns, over a long period. Understanding price behavior, business cycles, commodity cycles etc takes a lot of attention span.

In every investing journey, there are ups and downs. It never progresses as per the excel sheet design. Staying put in a SIP of an ETF (or an index fund as second choice)  is probably the safest way to preserve and create wealth without the stomach churn that accompanies direct equity investments.

One important thing to understand is that in direct equities, things are dynamic. For instance, our auto sector has been valued almost like FMCG companies. One day, maybe there will be no fossil fuel vehicles and all would be driven by alternative energy. Will all the old companies survive? We do not have answers yet. Every auto maker is ‘talking’ about his preparedness. The day of reckoning will throw up new winners and losers. Blue chips of yesteryears may fall by the wayside and new heroes emerge.  Technology companies seem to have very short life cycles. Last mile delivery platforms are constantly evolving and what is exciting today will be outdated tomorrow.

To sum up, learn your own tolerance for risk, before you choose the path in equity investing.

 

 

 

 

 

 

 

2 thoughts on “In praise of passive investing

  1. In India we do not have diverse index fund as S&P 500, would you go for nifty 50 index fund ?

    New BSE 500 fund fom icici has come, would you prefer that ?

    Like

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