A crisis of confidence has engulfed India and its financial markets. Investors are despondent about the macro situation, specifically concerned about the fiscal situation and current account, worried about the growing perception of policy paralysis, and questioning the trend rate of the country’s growth. Though investors are respectful of the Reserve Bank of India (RBI) and its guidance, no one is willing to give the current government the benefit of the doubt. This government has a serious credibility problem, with a negative perception about its ability to take decisions and lack of a holistic economic master plan. Investors will only believe in it once decisions are taken. Having burnt themselves out in the past two years owing to government indecision, until policy decisions are taken and corporate and bureaucratic confidence improves, don’t expect many of the big long-term investors to increase allocations to India.
Given this background, and all the issues surrounding Europe and its sovereign debt problem, why don’t investors just exit India and sit on cash? Why are investors not selling India in a much more aggressive fashion? After all, year to date, foreign institutional investors (FIIs) are still only slightly negative in terms of flows. This slight negative flow is despite economic growth and earnings estimates being cut and the RBI being far more hawkish than most had expected at the beginning of the year.
There are a few pertinent points here. First, India will continue to grow at least six to 6.5 per cent in terms of gross domestic product (GDP) and 12 to 15 per cent in terms of earnings (on a normalised basis). Though at 13 to 14 times, markets are not particularly cheap, they are not very expensive either. Earnings have not grown for two years now, nor is corporate profitability at a peak. There is a view that in a very bad global market environment, India still stands out as an oasis of growth. Growth naturally draws investors, and in a world of no-growth, they will invest in whichever country can deliver.
The second issue is that one can bet that we will get at least a tradeable bounce in India in the coming months. Markets are normally sensitive to monetary policy, and bottom out with the peak in the interest rate cycle. Markets will start moving up at least three to six months before any interest rate cuts. If one takes the RBI at face value, then there is a decent probability that we have just seen the final rate hike and could be about six months away from rate cuts. Thus, a market rally is on the cards, unless the inflation situation once again goes out of control and we see renewed rate hikes by the RBI.
So, given the possibility of a tradeable bounce, investors do not want to miss out. India remains one of the very few countries where monetary policy has scope for easing.
The third point is about being invested and trying to time the markets. Numerous studies have been carried out to show the futility of market timing. A study by Davis advisers tracks returns for the S&P 500 over the 15-year period from 1993 to 2007. In this period, for someone fully invested at all times, their returns were 10.5 per cent per annum. In case the same investor missed the 30 best trading days (not invested on those days), their returns dropped to only 2.2 per cent, and if you missed only the 60 best days over a 15-year period your returns actually went into negative territory, with a minus 3.2 per cent per annum returns profile. This is the huge cost of trying to time the markets; you miss 30 days and your annualised return over a 15-year period drops by 8.3 per cent.
A study on emerging markets by J Estrada of IESE Business School, “Black Swans in Emerging Markets”, comes to a similar conclusion. In the study, Professor Estrada looks at data for 16 emerging markets and 110,000 daily data observations. He shows that across all these markets and observations, if you missed only the 10 best trading days or .15 per cent of the days considered in the average market, your portfolio would be 69.3 per cent less valuable than someone fully invested at all times. Again, just being out of the markets for a fraction of the days considered can severely harm your long-term returns.
The Estrada paper looks at India and shows that missing the 10 best days for an Indian investor (over a 28-year period) dropped annualised returns from 20.2 per cent to 16.1 per cent. This is over 28 years ending 2007. A reduction of 4.1 per cent in annualised returns over 28 years leads to a 61 per cent lower terminal value — a huge difference.
For any investor who has been in India, this data resonate. The Indian market does tend to move very quickly whenever investors turn bullish or gain confidence. Take the case of 2009. Anyone underinvested in the circuit-up market move after the elections would have been unable to catch up in performance. Your whole return profile in 2009 and whether you were able to keep up with a surging market or not were driven by whether you were fully invested going into the election results.
One can, thus, easily see a situation in which if the government in Delhi were to take some tough decisions and India Inc’s confidence improved, the market can quickly and decisively move upwards. Local investors at present have limited exposure to equities and will drive a strong market rally if they gain confidence.
Given that the RBI is likely to have done its final rate hike of this cycle, many investors see this as setting a floor for the markets. Markets are unlikely to go down significantly from here if the RBI will start cutting rates soon. By the same token, if the absolute downside is limited from here, with a time-based correction more likely than a severe price fall, investors want to remain invested, given the tendency of the Indian markets to move sharply higher at the first signs of decisiveness and reform from Delhi.
Though many of us are very seriously concerned about the state of governance, lack of corporate confidence in India and the weakening macro situation, unless you see a large absolute downside, it may not be worthwhile to try and time market and stay underinvested from here, especially if you can find good companies at reasonable prices, many of which are now available. Despite being uncomfortable with the Indian markets in the short term, the odds and market history indicate you should consider getting invested, if you can take a genuinely long-term view.
Only if another Lehman-type episode were to occur would one go very wrong on this approach. Keep some cash for such a possibility. In any case, start getting invested.
As an individual you are only accountable to yourself, and don’t have the institutional imperative to try and maximise short-term performance, and minimise volatility often at the cost of long-term returns. Over a three-year horizon, you are unlikely to be proved wrong.
The author is fund manager and CEO of Amansa Capital.
akashprakash@amansacapital.com
