Equities are the best bet in the long run! I have lived my entire career with this belief and every time I have been tested, I have completely ignored anything that would challenge this belief. Whether it was the scams of the 1990s or the dotcom bubble of 2000, I believed in staying invested all the time. The global financial crisis too did not impact my commitment to staying invested. The last decade has been the worst decade in terms of investment returns for equity investors, yet I have maintained my faith in the equity markets.
Why? Because the equity markets always came back!
So, when COVID happened, my instinctive response was that we will eventually deal with the pandemic and come out stronger than ever before. However, there was a question that kept on haunting me – What if my instincts fail me? As I pondered over this question, I was convinced that I should revisit my investment assumptions and beliefs. This blog brings to you the outcome of my analysis. I sincerely hope that this blog encourages you to review your personal situation and build investment portfolios that are well aligned to your personal situation and the realities that you are facing at this point in time.
My Current Situation
Let me describe my current situation. There are three big changes in my life:
- I no longer have the benefit of a regular income. I am an entrepreneur now and am in the process of setting up my new business.
- My ability to handle the erosion in value of my investment portfolio has diminished. And
- As I am closer to my retirement years, generating regular income in the near future has become the biggest priority for me.
In the past, whenever there was crisis in the market, I felt it was an opportunity that I should take advantage of and I kept on increasing my positions in the equity markets. It was never a challenge to go through the crisis. But this time was different! I could feel that if such a downturn happens again, it would be a real struggle to live through the same given my high exposure to the equity markets.
So, I decided to challenge my beliefs and biases. The starting point was to review the historical performance of equity and debt in the indian markets. The results were startling, to say the least!
Equities are the best long-term bet, really?
Let us examine the long-term returns delivered by the Indian stock markets. If you consider the investment returns from the start of the BSE Sensex, the results can be very misleading. The BSE Sensex was launched in 1986 with the index value based at 100 as of April 1, 1979. Refer Table 1. I could easily notice the steep fall in investment returns of the BSE Sensex over the last two decades. In the decades of 1990 and 2000, the BSE Sensex has delivered a return of over 20% per annum reflecting the very high levels of inflation in the country. In the subsequent two decades, as inflation dropped in the country, the BSE Sensex returns also have dropped. The last decade has been the worst for the BSE Sensex. It managed a CAGR of only 8.9% per annum during this period.
Table 1: BSE Sensex - Long Term Returns
How does the Equity performance compare with Debt?
Value Research provides data on a fund category basis and this data is very useful to compare returns across various categories of mutual funds. Table 2 highlights the performance of equities vis a vis debt. I have further categorized debt into short term (Duration below 3 years) vs long term debt.
The results are shocking!
Over the last 10 years, equities have delivered returns better than debt but only marginally better! Further most investors invest in equities with a 3 to 5 year horizon. Over the last 1, 3 and 5 years, debt funds (except credit risk funds) have done better than equities across fund categories.
Table 2: Historical Investment Returns as of July 10, 2020 (Source: Value Research) (CAGR, % per annum)
The sad reality is that investment returns for equities have dropped and even if they do marginally better, the investors need a lot of patience and ability to withstand short term market volatility to benefit from the potential returns that equities can deliver.
Imagine if you would have invested in the equity markets with an expectation of generating investment returns of 12% p.a. to 15% p.a., you would be totally disappointed.
What If you relied on generating these investment returns to meet your long term goals like education or wedding expenses of your children or your own retirement?
Clearly, I had under-estimated the importance of adding fixed income to my portfolio. Not only that, I had over-estimated my investment return expectations from equities. This analysis ensured that not only do I reset my return expectations but also work towards getting the right balance between debt and equity from my personal perspective.
Can fixed income products beat inflation?
Fixed Income and that too for the long term – Yuck!
That’s how I used to think about fixed income. This was ok as fixed income was believed to be incapable of beating inflation. India has had a history of very high inflation and in those days, fixed income could not even match the rate of inflation. So, why invest in fixed income?
First, let me share the inflation rates in India over the last decade. India has managed to bring down the inflation rate significantly over the last two decades.
Inflation Rate in India (Soruce: Macrotrends.net)
As you would have realised, fixed Income has actually generated a real return for investors. I had to really challenge my beliefs to accept this reality.
Further as you would have noticed in Table 2, the long duration fixed income products have done much better than the short duration products. To be honest, the timing of the analysis does matter a lot, but nonetheless it makes sense as even debt investors expect a higher return while investing for the long term.
Fixed Income - Key Findings
The summary of my research on fixed income is as follows:
- Over the last decade, the Indian Fixed Income markets have beaten inflation and delivered a real return to investors.
- The performance of long term debt is far superior to performance of short term debt.
- Credit funds have delivered poor returns. Hence sticking to high quality credit is crucial while investing in fixed income.
How have I re-aligned my portfolio?
The first thing that I did was to calibrate my asset allocation to the new realities in my life. I have increased my exposure to fixed income. This gives me the comfort that even if equity markets disappoint, I have the ability to stay invested as long as is needed to generate superior returns.
In terms of fixed income, the most important learning is to have investments across all maturity buckets. Long term debt funds work extremely well if interest rates drop. Similarly short term debt does well when interest rates are expected to rise. Though we are at historic lows in terms of interest rates, the post covid world will force central banks across the globe including India to keep rates low. Unlike the western world, India has been lucky to have positive interest rates. But to assume that we are at a lowest point in the interest rate cycle may not be right. Hence there needs to be some allocation to long term debt even if the rates are very low.
In terms of my personal expectations, I do believe that the coming few years could be disappointing in terms of investment returns across equity and debt. We are moving to a new normal and it is difficult for anyone to predict what it has in store for all of us. All we can do is stay alert and nimble and keep searching for good investment opportunities.
Conclusion
Today, I feel a lot more confident of the future in terms of my investment portfolio. My motto for the current times is “Safety First, Returns laters!” I believe I have all the weapons in my arsenal and there will always be some investment that will do well irrespective of what the future has in store!
The #1 investment lesson is and will always remain – STAY DIVERSIFIED!
