Law of averages should favour the equities in coming year

Market is a place where ‘people with money’ meet ‘people with experience’ and often lose money and gain experience. The year 2011 has been a difficult one to make money. But it has taught a few good lessons.

The first rule in investment is ‘price'; it is what you pay and ‘value’ is what you get. In the beginning of 2011, there was little value in equities (though not many said so explicitly) and, more importantly, it kept deteriorating during 2011. Prices kept on chasing the ‘value’ on the way down through 2011. At the end, the value has gone a little below the ‘price'. But the momentum will take down prices further in the near term. The Sensex is trading at a level that was first seen in mid-2007, and earnings have grown 40 per cent since then. The law of averages should favour the equity investor in 2012.

The second rule is that return of principal (safety) is more important than the return on interest. Credit risk, which has remained minimal for Indian retail investors for the last many years, has come to hound global investors, especially the foreign currency convertible bond investors and structured financiers in the real estate. Lessons of losing hard-earned money in plantation companies and non-banking financial companies (NBFCs) have not been forgotten by retail investors. Hopefully, now, global investors will also price credit risk correctly. Every investor in the Indian fixed-income market will have to remember it is not just the ability to pay that is critical, but also the willingness to do so.

The third rule is that generally consensus creates over-confidence and unexpected consequences. When the rupee was at 45/$ in August, the consensus was marginal appreciation of the currency by the year end. The overvaluation on inflation-adjusted basis was missed by the majority. No wonder, the rupee has caught majority of people off guard. Gold also gave a similar shock to global investors, as it corrected in the second half of the calendar year. This shock has not been felt by the Indian investor because of the rupee depreciation. The consensus of bearishness on equity and rupee, in that sense, augurs well.

The fourth rule is about discipline in investments. We heard rumours about marquee names losing money in currency, equity and commodity markets in 2011. An investor with a discipline to stick to asset allocation would have taken money out of equity in the first quarter of the calendar year (CY) and invested in fixed-income instruments. He would have invested in gold in the second quarter. Thus, he would have generated noteworthy performance in a very difficult year. Discipline is the key ingredient for success in all fields and investment is no exception.

The fifth rule is not to take all experts at face value (including this author). 2011 has proven the futility of an expert’s opinion. In a rapidly changing world, majority of predictions have gone wrong. The key is to take the future as it comes, but maintain the discipline to take corrective action when necessary.

I still can’t resist recommending a strategy for 2012 (CY). Maintain higher durations or maturities in the fixed-income portfolio, notwithstanding recent rally in yields. In equity, one will have to buy in a declining market, with lots of patience. Yes, the constant decline will hurt. But, that pain will be rewarded in the second half of CY12.

The time to buy is when everyone else is selling and vice versa. In real estate, many developers are now offering attractive prices for bulk buying. One could join hands with other like-minded people and increase their bargaining power for a better deal.

Gold is probably going to correct in the first half of CY 12 on the dollar’s strength. However, that will be a good opportunity to invest, as dollar today is driven by the ‘safe haven’ or TINA factor. The rupee, after having lost 20 per cent this year, is likely to be range-bound in the first half. Happy investing in 2012!

The writer is president, Corporate Banking, Axis Bank. Views expressed are his own.