FOUR MYTHS ABOUT INVESTING IN INDIA
The challenge for affluent Indians who are trying to get their financial planning
on track arises from two different sources. Firstly, manufacturers of financial
savings products and the intermediaries of such products are marketing
proactively, and sometimes aggressively, to get a slice of the Indian HNI savings
pot. Often, these marketing/advertising campaigns have little to do with the facts
on the ground. The second challenge facing well-intentioned Indian HNIs is
themselves—most affluent investors live in an environment where myths around
the pros and cons of various investments proliferate. These myths are often the
biggest driver of the investment decisions affluent Indians make. We now
highlight the four myths that we encounter most often in our discussions with
HNIs.
MYTH 1: GOLD WILL HELP ME PROTECT MY WEALTH
An RBI report found that next to real estate, gold, at 11%, accounts for the largest share of the wealth of Indian households. An 11 per
cent allocation to any asset is a reasonably large chunk by any standard. How
has such a material asset allocation worked for Indian households? Over the last
ten/twenty/thirty years, the price of gold (in rupee terms) has compounded at an
annualized return of 9.2 per cent/12.7 per cent/9.3 per cent, respectively. Over the same time periods, an investment in the
equity markets, represented by an investment in the BSE Sensex index, retuned
10.4 per cent/15.0 per cent/14.8 per cent, respectively, higher than gold in each
time period. If we consider returns from gold in each of the three decades
separately over the last thirty years, we see that gold has underperformed the
Sensex by a wide margin.
MYTH 2: REAL ESTATE WILL HELP ME GROW MY WEALTH
Over the last five years, if one were to look at the return rate from real estate in
metropolitan cities in India such as Mumbai, Delhi and Bengaluru, one would
see that returns have been around 3–4 per cent per annum; i.e., house prices have
at best kept pace with consumer inflation. Real estate in major markets like the
National Capital Region has not even accomplished that. However, there is a
school of thought in India which says that because residential real estate returns
have been weak over the last five years they will be better going forward. This
point of view cannot be sustained when one compares Indian house prices with
the prices prevalent in other markets. The first problem is affordability. Secondly, Indian residential rental yields are around 2–3 per cent in most Indian
cities, whereas the cost of a home loan for prime residential real estate customers
is around 7 per cent. The disparity between these numbers suggests that Indian
residential real estate still has room to correct from its highs before it becomes an attractive asset class.
MYTH 3: DEBT MUTUAL FUNDS OFFER DECENT RETURNS WITH
LOW VOLATILITY
The yield of a debt fund depends on the credit quality of its
portfolio. All corporate debt is ‘rated’ basis the probability of the corporate
defaulting on its debt obligations. The debt issuers with the strongest balance
sheets get a rating of ‘AAA’, implying that their probability of default is similar
that of the government. In contrast, the companies with poor debt management
may get a rating of ‘B’. There tends to be an inverse correlation between the rating enjoyed by the
debt issuer and the YTM on the issuer’s bonds, i.e., companies with the strongest
ratings enjoy the lowest YTMs(Yield to Maturity). That, in turn, means that a fund manager who
stuffs his debt fund full of highly rated bonds will have a fund with a low YTM,
and hence the debt fund will give low returns. However, that will make the fund
unpopular with the army of salespeople who sell such products. So, fund
managers who want to earn big bonuses tend to stuff their debt funds full of
bonds with low credit ratings. Such funds deliver high returns for a few years,
but when defaults occur (low-rated bonds have high default risk) the whole thing
blows up and millions of investors find that their savings in debt funds are worth
much less than they thought they would be.
MYTH 4: GDP GROWTH DRIVES THE STOCK MARKET. SO, IF I (OR
MY WEALTH MANAGER) CAN TIME THE ECONOMIC CYCLE, I
CAN TIME THE STOCK MARKET
In a blog post published by Marcellus in November 2019, they have shown that
the relationship between Nifty50 EPS growth and GDP growth seems to have
completely broken down in the last five years. More generally, across the world there tends to be low or no correlation
between stock markets and GDP growth, implying that timing the stock market
is not possible on a systematic basis. Ben Inker of the fund management house
GMO, in an article in 2012, concluded that ‘Stock market returns do not require
a particular level of GDP growth, nor does a particular level of GDP growth
imply anything about stock market returns.’
The valuation guru Aswath Damodaran says that the causal relationship,
instead of running from GDP growth to the stock market, instead runs the other
way round, i.e., stock markets are predictors of GDP growth (rather than being
‘reflectors of GDP growth’). He highlights a 30 per cent correlation between
stock market returns in the US in the period 1961–2019 and GDP growth four
quarters hence.
It is in the best interest of the investor that he/she should know the myths about investing in India, ignore them and always ask why or how in any financial advice given to them. Do not blindly follow any financial advice just because your friend or a person you trust has suggested so. This can be very devastating and you may not be able to achieve your financial goal before or at the time you anticipated.
I hope you all liked the blog, do share it to your loved ones to help them achieve their financial freedom absolutely for free !
~ Pranit Bhandari