Investors who stick to quality portfolios make the most money

10 Mar, 2008, 2220 hrs IST,Tushar Pradhan,

The domestic stock market has been witnessing considerable volatility and there are concerns about its future direction. However, news so far about the domestic economy and corporate sector is not really causing concern.

Nevertheless, nervousness regarding the unfolding events, post subprime crisis, continues to impinge on the minds of overseas investors. Foreign portfolio investors have been reducing their exposure to equities in the region. In the year so far, India has seen a net negative outflow of nearly $3 billion.

South Korea saw the highest outflow for the year so far, at $9.25 billion, followed by Japan at $1.4 billion and Taiwan at $1.2 billion. Given the current shallow nature of markets, this has led to a steeper correction than would normally be warranted by such an outflow. The market has also seen withdrawal of several IPOs, which indicates lack of interest in the retail segment. Investors’ confidence, which was bordering on euphoria earlier, has now been tempered to a large extent.

This, combined with India Inc’s sluggish third-quarter results, has put a question mark on the sustainability of companies’ earnings growth. During Q3 FY08, earnings growth for the Sensex group of companies stood at around 16% year-on-year (y-o-y).

This compares with 25% for Q2 and 30% for Q1. At 23.6%, the average growth for the three quarters is still healthy and well in line with the full-year estimate of 20%. But the manner in which growth has been attained indicates a slowdown. So, what has changed in the market? The answer is: investor sentiment. The market is driven by perception, rather than reality, in the short run. As of now, news emanating from the US and other parts of the developed world is not encouraging. This reinforces the perception that the going will be tough in future. However, in the long run, these may just be blips on the growth chart.

Though investors do have concerns which make them think twice before venturing into the market, one must not forget that returns are gained only by undertaking risk. So, what appears to be a bleak situation (under normal circumstances) is the cause of abnormal gains if the bet is called right. In the strictest sense of the theory of efficient markets, no one would make abovenormal gains otherwise.

So, these fluctuations, driven by a mixture of facts and sentiment, are the quagmire that investors have to face on a regular basis. The relentless rise in the market over the past three years had desensitised investors to a large extent. Hence, the above phenomenon seems difficult to understand as of now. Most investors are also in denial at times, which generally (if the market continues to fall) gives rise to despondency and eventual capitulation.

Nobody claimed that the equity market is meant for everybody, or that it is a safe place to be in, or that it is a place to make easy and free money. Patient investors who stick to quality equity portfolios through thick and thin make the most money. Studies dedicated to buy and hold strategies have proved this time and again. The market is self-correcting in nature. In the long run, it’s capable of pricing assets efficiently. But in the near term, it’s harder, if not impossible, to predict.

Opportunities abound at the current market level. However, these opportunities may not lead to immediate gains; a much longer outlook is required for gains to accrue to investors. What is undeniable is India’s appetite for infrastructure development and increasing consumerism in the country. If the domestic market is aided by a benign interest rate regime and supportive regulatory framework, it may become the best market in future

Chief Investment Officer – Equities, AIG Global Asset Management Co (India)

VIA:E.T