Boom Time in Dalal Street

The ‘exposure to equity’ escalator rider
Remember those long escalators in airports? They get you to your destination eventually. The unexciting ride allows you to make calls and fuss over the luggage. You continue doing your thing while the system takes you forward. An investor who is looking for an exposure to equity is like an escalator rider — she passively wants an instrument that will outperform other asset classes and provide growth to keep her money’s purchasing power cruising faster than inflation. She does not want too much threat to her money and is willing to trade supernormal profits for steadier returns.

Such an investor need not track the market on a regular basis to benefit from the growth that equity gives to a portfolio. She will most likely be a passive investor in a mutual fund, usually an index fund or a managed fund like a diversified equity fund. At most, she may venture into a sector fund to punt a bit.

She likes the fact that the market index, the Sensex has given a compounded return of 17 per cent over the last 25 years. In those years, inflation has been rising at about 7 per cent per annum and fixed deposits have given an average of about 9 per cent per year. Closer to today, if she had bought an index fund that mimics the BSE Sensex on June 1, 2004, she should have got a return of 28.8 per cent till December 2, 2004. Had she been more adventurous and bought into a sector, the return would vary around this average return (see chart The Escalator Return).

If you identify with the Escalator Rider, you should continue to hold onto what you have, unless you are closer to your financial goals or at the exit price that you had in mind for your equity portfolio. The equity market moves in cycles and we are in the middle of an upward trend that lasts for anything between three to seven years. Cut out the noise of a booming market and enjoy the ride.

The equity roller- coaster rider
Roller coaster rides have a health warning: ‘Those with heart, back problems and vertigo should not ride’. A direct equity investor faces a market with this warning written clearly in the rules of the game. A direct equity investor is like this roller coaster rider – she enjoys the rough ride and gets a kick out of beating the market average. She does not mind the risk, but wants to grow her money very fast. She is active in the market and has five to 50 stocks in her portfolio and would track between 15 to 250 companies. In a good year she could make supernormal profits, but is equally liable to lose much of her capital with some wrong calls.

The buy, hold or sell decision for such a person depends on how she values the company in question. An astute equity player would have bought into Infosys, Wipro and ITC earlier this year and sold off HLL, Nestle and Ranbaxy (see chart The Roller Coaster Return). But few people actually make the right equity calls all the time. The fact is that the average return of even an active portfolio tends to the market average over the long term. We picked sectors, and companies in those sectors, that have a high investor interest, purely randomly and found that the average return in this portfolio did indeed tend towards the average return of the market.

However, if you are a direct equity investor, a passive buy and hold escalator ride is not for you. You need to take active calls on your portfolio. The buy and sell decision should have more to do with how you value the company rather than how high the market will take the stock. Sell, if you think that the stock you hold is overvalued. Dropping margins in HLL have been there for all to see for the past few years and smart investors got out of the stock long back. Those holding HLL have made 6.8 per cent over the last seven months, compared to 60 per cent that an Infosys investor would have made. Remember, FII cash is hot money and can flow out as soon as it has flowed in. Keep the focus on valuation of the stock you hold and plan to buy.

Post script: And there is a third kind of investor the Bungee Jumper. He invests only when the markets reach their highest points and sells when markets tank. Such an investor would have sold after the 9/11 crisis. Would have sold on May 16, 2004. This investor is breaking FDs today to jump into the market full pep. The Escalator Rider and the Roller Coaster Rider will get somewhere, but this Bungee Jumper will surely bang his head.