Some notions on notional losses

ME: Sir, you just lost your shirt on the Street.

HE: Oh did I? How does it matter? I am here for the long term and nobody goes to the grave with his shirt.

Investing for the long term has its benefits. One of these is that nobody can question your decisions in the near term.

Last week, some media reports pointed out the notional losses on investment decisions by some big institutions, evoking some strong responses.

I heard on the Street that some officials were so pissed that they even planned to issue a statement, attacking the very idea of analysing notional losses. It was the work of inexperienced authors who have little knowledge of financial matters, the proposed statement is said to have read. Such sensationalised analysis was aimed at scaring away investors and they should not believe such reports, it went.

Another defence the fund managers like to put forth is that they invest in blue chips, which are forever and they will definitely give good returns in the long run. They also cite the tried and tested examples of Bharti and Infosys. But, two apples don’t make an orchard. A cursory look at the Sensex constituents over two decades will tell you many blue chips have disappeared from the index over the years.

If notional losses are immaterial, why do international accounting standards demand firms to mark their investments to the market value periodically?

Notional losses are important because they could potentially impact the future value of your investments. Take, for example, you invest Rs 100 in a stock with the aim of making it Rs 200, in say, 10 years. You are expecting the investment to grow at a reasonable rate of around 8-10 per cent annually. However, if you take a hit of 50 per cent in the first year itself and your capital is down to Rs 50. You have to double your growth rate in the remaining nine years. On the other hand, if you had just sat on the cash and did nothing, you would still have had Rs 100. Which is easier - 100 to 200 or 50 to 200?

Thus, it is important not to make huge losses in the early stages of your investment. That is why many smart early investors even negotiate and enforce conditions, which bar a company from selling shares at a lower price at a later date. Even smarter ones set the minimum threshold price below which the initial public offer cannot be made.

How do you, then, justify nearly 10 per cent losses on Day 1 and 25 per cent losses after two years?

Given some of these institutions manage public money for a life time, the people who make the decisions today will be long retired and drawing their pension cheques when the final outcome of their decisions hits the end-user — the investor.

So, who will audit the investment decisions of people and institutions that invest for the “looooong term” and the rationale behind those decisions? Who is accountable if these decisions go wrong? Often, simple questions have no simple answers.