A lot many Indian families have been sold the idea of taking part in the great Indian bull-market game. Quite a few have tried this and met with some success as well, and now think that this is a no-brainer. I work in the financial services sector and I can state with reasonable conviction that it is not easy to generate solid returns year after year. There have been a lot of myths sold to retail investors in order to make them cough up. As a kind of guilt-reduction exercise, I want to explode a few of them.
1. Equities may be a riskier asset, but if you are investing for a long time, they will definitely generate better returns: This is pish tosh. Most long-term calculations are biased by the starting date, and therefore most statistics presented are wrong. Let me explain this with an example. If as a small investor, one had entered the market in 2006, the long-term argument will hold good, but anyone who entered when the sensex was anywhere between 18-21K might not see this argument bearing good even if we stretch the definition of long-term to 50 years. If over any stretch of long-term, equities generated better returns, then this is not a riskier asset class, it is the juicier asset class.
2. Small investors are not at a disadvantage: Think about this. The industry has 3 kinds of participants, domestic institutions, foreign institutions and small investors. The first two move the market, and the third is a price-taker, and this is a zero sum game. This is how market mechanism works – Company of reasonable size keeps peddling its own investment story, Fund managers hear the story and build positions; one of the sell-side research firms picks up on this and writes research, some more fund managers like story and buy stock; some retail brokers follow suit and write about the investment idea, the small investors also get in and the stock price keeps going up. Who do you think is selling? In the first 2 phases it is some promoter, in the third phase it is the fund manager. The key to an investment idea is not whether or not you understand the story, it is whether you are amongst the ones who are early to the story. A fortnight after the elections, the buzz word among retail investors was how infra would be a major theme for this government. At least 4 fund houses held conference calls with psephologists before election results were out. Infra stocks were up 50% in the first 2 weeks after election results. By the time the retail investors get into the theme, it is already done and dusted.
3. The guys on TV are really smart, and therefore get things right: I worked for a large sell-side firm. Journalists from Bloomberg or Dow Jones would call our offices once a month to have a chat about this and that. I would give him/her the most sanitised dope possible, sans name/organisation. (The stated internal rationale for this was that our clients pay for our research, they would be angry if we gave it away for free; the real reason is that in most cases, we are really not sure what is going to happen and wouldn’t want to get sued). These journalists would spin a story out of this which would then get picked on by the TV guys. As a sell-side analyst, I was generally late to the game as the buy side guys had more at stake, more resources and were generally better than me. The best buy-side guys got may be 60% of their calls right. TV analysis is at the fag end of the investment analysis-chain. They still sound smart because they are good at packaging and are perhaps at the beginning of the retail investment analysis chain. In a reasonable market, a major insight uncovered by good analysis lasts perhaps a week. This is roughly about the time the insight takes to find itself on TV screens. So, if you invest based on TV analysis, be prepared for some rude shocks.
4. A lot of small investors make very good money: Remember this is a zero sum game. Most small investors get s*ckered into this because someone they know has struck it rich by just randomly punting it on the market. All investors like to talk about their investments that worked beautifully. This is true of mutual fund managers, hedge-fund guys and small investors. When things go well because the market is going up, people give themselves credit for picking the right stocks. When things go wrong, they go quiet. So, anyone hearing these jokers will assume that they are rockstars of the investment world. They are not. (Nobody is, the market is a great leveller. More on that in another post). Rising tide takes all boats up, the oarsmen take credit for this; and when the tide recedes, they go quiet. You will hear the odd story that someone has gone bust because of stock investing, but this is not all. Most guys enjoy trading in bull markets, lose a lot of money in bear markets and keep their trap shut about this. Chatter is directly proportional to return levels.
5. Blue-chip names are generally safe bets: Again, think about this. Blue-chip names are among the most researched in the market (There are perhaps 40 sell-side analysts covering Infosys, there will be another 50 buy-side analysts covering the same name). There are guys who have spent 10 years in just studying the 25 names that are so-called blue-chips. So, even if they are stable and solid, you will get beaten to the best returns by the guy who goes to the same club as the CFO. So, you are likely to generate better returns by placing money on the index. There is a huge difference between a good company and a good stock.
6. The financial markets are very ethical and take care of the small investor: Hahahaha. This is a whole new can of worms. One can write an entire book on ethical standards in the financial sector. Let me at least set this aside for another post.
So, what does a retail investor do? Generally, market return is classified into two types – alpha and beta. Beta is just what the market returns, while alpha is what the “skill” level of the money-manager returns. By definition, the cumulative alpha of all market participants has to be zero. According to me, the best strategy for retail investors is to go for beta, and build portfolios where they won’t get smacked by huge negative alpha. In essence, time your overall market entry, don’t get s*ckered into the absolute lemons, and for the love of god do not fall for the temptation of trading more when the going is good. The simpler version of this is to just punt on the overall market and not get into specific names. If you want to trade on khabar, do not use your brains to verify whether khabar is likely to be right, rack your brains to figure out if you are the first to the khabar. Baseless khabar can generate returns if you are the first to hear it; and vice versa. And develop a temperament to handle volatility in returns without letting it affect your health. If you cannot do any of these, place your money in FD’s and pray that this bull-market madness comes to pass.