Is Equity the Multi – Bagger amongst all Asset Classes??

One of the most predominant features of the ‘so –called ‘developed economies is its depth in their financial markets and the financial Industry, with about 30% of their savings being infused in the market instruments. However, Indians in general do not seem to have the faith, of their savings being captured in the gamut of market instruments. The recent affairs seem to have consolidated this fact. The year 2012, saw 55,000 cr being redeemed from the Equity Mutual Fund Space wherein FII’s pumped in $23 Billion in the Indian Markets.

Now those figures are mind – boggling .Its enticing as to why less than 5% of the household Savings in India is invested in Equity Mutual Funds. This write up pretty much tries to analyse that.

One of the primary reasons, of course is the lack of investor education and how there is no substantial penetration in the Tier2, Tier 3 cities. These figures, even made SEBI wake up from their slumber and take some rectifying actions. The Rajiv Gandhi Savings scheme launched in September was one of the primary steps taken to incentivize investing in Equity with tax breaks as an important feature. The next step was incorporating more safety measures for a retail investor with Regulations like Direct Plans and Actions on Mis-selling. Perhaps this would propel the retail towards the equity market.

Another concrete reason why an Indian abstains from putting the surplus in equity is his/her belief in physical assets like Real Estate and Gold. It’s undoubted that these asset classes have given phenomenal returns over varied time frames.

But the corollary to this is , the equity is not well analyzed .Every asset class has its pros and cons .And the Equity as an instrument is devoid of too many cons. Let me name a few pros to begin with which is not a pre-dominant feature in the other physical asset classes. They are Liquidity, Diversification and Systematic Investing or Leveraging risks. Generally Investments are made with a certain purpose /goal. When that goal needs to fulfilled, liquidity becomes an essence that cannot be missed on. Diversification into different categories or Schemes of equities makes the scope of loss even lesser. Systematic Investment Planning across time frames will average out the bears and bulls garnering sumptuous returns. So these pros give Equity an edge.

To further assess, a chart of performance asset classes is extracted. The premise being, Equity Mutual Funds is the universe of Diversified Equity Segment, the Real Asset considered is the Delhi –NCR region and data considered is till March, 2012.

The chart suggests that the last three years equity has done marginally better than the Real Estate Category with a 29 % CAGR returns compared to a 27%, where as in the 5 year period it was a dismal 8 % CAGR. An exceptional year of 2008 ushered in the down-slide. However, if we increase the band-width to a ten year horizon then 23 % CAGR in Equities with additional features of liquidity, Professional Fund Management and Diversification of Risk is a feather to the cap. Even gold hasn’t managed to cope with those figures despite being the best hedge against inflation and financial turmoil. Real Estate undoubtedly managed to win the game in terms of returns, but the hassle may not be worth it. Real Estate generally implies locking up a huge corpus, piled on with EMI’s and the exorbitant high interest rates in India, maintenance of the property and not to forget insuring it against the worst come scenarios. All these hassles are eliminated in Equity, though the risk of capital erosion will always be pertinent.

Taking all of the above into consideration, the next thought that comes to us is the future of these asset classes. If analyzed well, we understand that the upside of the equities is Unlimited whereas the upside of Real Estate and gold is limited. Wouldn’t we all agree to that?

The equities are at a nascent stage in India and the scope of growth is massive. Every developed country has immense depth in its financial markets and that step would be taken for us to reach that pedestal. According to us, the financial services are bound to see phenomenal growth. As the chart below deciphers, the upside from 1991 upwards .Most likely the trend will remain upwards. One of the prominent reasons being the growth of the Companies underlying will always see more growth than GDP of the country and that has been the trend of any growing economy.

The reason for limited Upside in Real Estate will be for varied reasons like Expensiveness of liquidity, lack of availability of Service Urban Land and thus Land Acquisition costs will sky rocket, Delays in Approvals and general pace of construction. All these factors could certainly prove to be detrimental for the sector. The 96-99 plummeting of prices in Real Estate prices is a live example.

Equities when compared to Gold are a clear cut winner in terms of performance over years. Gold is an exhaustible commodity with its set of cons. Its utility scope is limited, purely used for hedge and sentimental reasons and thus usually not recommended more than 5-10 % in an individual’s portfolio.

To further highlight Gold v/s Equity, this chart has been extracted. Over the span of thirty years, Rs 100 invested in 1980-81 in Equity has culminated to Rs 10,060 and Gold is Rs 1690. There is a very good possibility that the next thirty years could give similar returns.

Conclusion: - The final verdict after understanding the asset classes is that Asset Allocation is imperative and every individuals risk appetite should be measured. Real Estate and Gold are certainly not bad Investments. However it demands a lock in of huge amounts which may not be affordable after a certain point in time for majority of the population. As we see, the prices today are sky rocketing and is an investment option which is confined to the affluent class. In comparison, equity has a good scope. If investments in equity are done with absolute discipline, appropriate study and Expert-advise, then garnering decent returns and achieving goals will be an easy deal.

RBI V/S THE GOVERNMENT !

The GDP is seen at its 8 year low at about 5.5 % v/s a WPI inflation of about 7.6 which is not as bad as in comparison to the last 3 years. So the predominant question that surfaces is whether growth is the primary agenda or is it about curbing inflation? The RBI has been incessant on maintaining its stance on having lower headline inflation and thus having strong resistance in cutting down interest rates any further. The previous repo cut happened in April 2012 with the likelihood of it happening again on the 29-1-2013. The CRR rate was cut by a 25 basis point earlier this year. The normal notion lies that the CRR rate cut is followed by the cut in the repo rate.

However the question that still lies to be answered is how important is it to cut rates at this juncture.  Will growth re-surface if the interest rate cut has been implemented? The fact that is intriguing is why growth was prevalent in the last three years when inflation kept rising. The several factors that could have led to a decline in growth is the high levels of corruption, higher subsidy bills, poor distribution channels, slower reform processes and the languishing pace of infrastructure . This contributed to growth plummeting and inflation rising. So to my knowledge unless these problems are rectified there is no scope of steady or increasing growth.

The next question that features is what are the ramifications of an interest rate cut? This will propel an increased corporate and retail borrowing, which will in turn lead to increased growth. Currently the government is only trying to curb expenditure but without increasing sources of revenue. The recent measures of divestment, rationalizing diesel prices (which do contribute to inflation) were some of its means to curtail expenditure .Hence it becomes imperative for new sources of income to be generated.

Printing of money will only lead to inflation. So productivity and supply side constraints are the main parameters that would be the primary agenda to limit inflation. However, there are certain factors like import bills of crude, gold and increasing real estate prices which is putting a massive pressure on expenditures and inflation. It is a known fact that India as a country charges a very nominal sum on its oil products in turn leading to losses for the oil companies and the government treasury. If crude products are rationalized and market demand –supply oriented then, it will contain or reduce expenditure.

 The recent moves by the government seem to have ignited a certain positive sentiment in the market. It is evident that the government is compelled to act in perspective to the elections that are featuring in a year’s time. The FDI in retail and Aviation was essentially a strategic move to setting the economy in momentum and other the policy overhauls in mid September 2012 worked in the governments favor.

So again I come back to the question what is more essential growth or curbing inflation. What seems to be a graver problem? In my opinion, everything is linked. So if growth features in with the requisite productivity and streamlining of processes and reforms happens then inflation will wane off gradually to a decent level. Though the RBI is not wrong in resisting the rate cut, the prospects of growth versus that seems higher. Obviously the impediments and deterrents needs to be eliminated and investments on factors like infrastructure should be a priority to stay in tandem to the general growth.

Thus there has to be a balance in curbing expenditures and increasing revenues. Though the RBI would have its own reason, curtailing the fiscal deficit should be a priority as India has a problem of twin deficit which involves current and fiscal deficit which has to be the government’s primary concern. That generally leads to the Rating agencies downgrading our bonds and leading to a lesser inflows of FII money. We all know if that inflow was absent, then the depth of our market would have been a very shallow deal. And the 20 K Sensex currently would have stayed put at about 4-5 k (An approximate figure). Foreigners have purchased a net $18.7 billion of local shares this year, the most among the 10 Asian markets tracked by Bloomberg, excluding China. India's gross domestic product will increase 5.8% in the year through March 31, the Reserve Bank of India said on October 30, the slowest pace since 2003. This implies the consistent positive sentiments and growth prospects will have to sustain to attract investments from global arenas.

Thus if these reforms and measures sustain ,if the import bills and subsidy bills reduce and corporate earnings increase, then the rate cut is possibly a very good measure and reduced inflation will follow suit.

Source of Image :Economic Times.