A rational optimist can make good money in the equity markets.
Marketers often cite the apocryphal story of the two shoe-salesmen of contrasting attitudes who check out the potential of a remote tribal region. One returns shaking his head in disappointment because none of the savages wear shoes. The other rubs his hands with glee for precisely the same reason! The moral is supposedly that attitude and optimism makes a difference.
However, there are more nuanced ways to see such situation. The optimist sees a virgin, untouched market with zero competition and assumes it can convert into huge sales. The pessimist sees ingrained cultural attitudes that might not change easily - if at all.
The (mythical) tribe may have some religious or cultural injunction against shoes. It may even be actively dangerous to try to change their habits. Substitute “religiously proscribed food item” for “shoes” in the story and consider the possible consequences.
I remembered this story in the context of Indian household savings habits. Just about 5 per cent of Indian savings are held in equity and debentures combined (E+D), while about 80 per cent is parked in bank deposits and insurance combined.
Only about 1.5 per cent of Indian households invest in financial markets at all. There are about 15 million demat a/c holders compared to 450 million bank a/c holders. This contrasts with a global picture, where around 60 per cent of households are invested in E+D and around 50 per cent of household assets are parked in E+D.
This skew in the asset mix is usually glibly written off as Indians being risk-averse. But that really doesn't hold up. Indians take huge financial risks without blinking. They park huge assets in dodgy, high-risk real estate schemes, regularly get scammed and proceed to lose their shirts happily in the next real estate scam.
Gambling in general is not just a popular Indian pastime; it is religiously mandated. The entrepreneurial spirit of “dhanda” is celebrated (or reviled) the world over and dhanda often means betting everything the businessman possesses.
Part of the problem is the lack of a secondary bond market and the lack of decent bond issues. That certainly means lower E+D penetration than the global norm since the “D” market is thin. But it does not explain such a stark contrast in asset mix. Obviously, there's a specific mental and cultural block against holding equity. Where does this equity-aversion come from?
There are dozens of aggressive Indian financial service providers. Instead of trying to crack that conundrum, many of them have perpetrated it in order to fatten their own margins. After all, if a financial service provider induces somebody to invest in low-earning debt or insurance instruments, and then invests that cash in high-earning equity or bonds, the service provider keeps the spread.
If you get past the equity-aversion and ignore the attempts of service providers to push low-earning instruments down your throat, it is however, an almost virgin market. Indian equity can give extraordinary returns because Indians are equity-averse.
In the past decade, rupee inflation has run at around 7 per cent per annum, while the Nifty has returned over 13 per cent CAGR (capital gains plus dividends yields). There's no reason to assume returns will drop since the trend rate of GDP growth is accelerating. The equity exposure of Indian households may grow with time- it cannot drop because it's at rock-bottom.
Part of the equity-aversion is also because most individual Indian investors mishandle equity investments. In fact, the average Indian equity investor isn't an investor; he's a get-rich-quick trader. Very few actually use buy and hold strategies focussed on stable businesses. Most are looking for extraordinary returns in very short time-frames.
There's nothing wrong with trading equity for quick gains. But then the trader needs to follow optimal strategies and manage stakes carefully. Very few bother to do that. Most just punt randomised amounts on gossip and rumours and they are prone to betting n strange fly-by-night companies.
As a result, most investors have hard-luck stories to tell and everybody knows of some acquaintance or another, who lost his savings playing the share-bazar. The few that make serious money tend to keep their lips zipped for fear of attracting the attentions of income tax officers. This creates a skew in perceptions.
In a downturn, the hard-luck stories multiply and scare off possible entrants. This is where the rational optimist may sense a big opportunity. Properly managed over the long-term, equity gives excess returns. Properly managed over the short term, it could give fantastic returns. The key lies in proper management.
