Somebody calculated the possible returns from saving and investing Rs 10,000 per month, systematic investment plan (SIP) fashion, over a period of 20 years, starting in 1996. This is a realistic concept — a salaried middle-class person might easily do it.
The savings corpus amounts to Rs 24 lakh. If this Rs 10,000 was parked month after month in the Public Provident Fund (PPF), a fixed income instrument with risk-free return, it would be worth about Rs 43 lakh. If the same amount was put into a Sensex index fund, it would be worth Rs 1.06 crore (neglecting expense ratio).
The difference is startling. It is surely enough to convince the doubters that equity investments are worth higher risks. In fact, the risk is not too much when the investor is looking at such long-time periods. The volatility tends to even out.
It makes sense to use “rolling returns” to calculate returns for an SIP. Say, an investor parks Rs 10,000 on the first trading day of January 1996, when the Sensex was 3,114 (closing price of January 1, 1996). He parks another Rs 10,000 on the first trading day of February 1996 (Sensex at 2,929). On the first trading day of January 2006, the Sensex was 9,422. So, the January 1996-2006, 10-year return was 202 per cent (absolute). The February 1996-2006 return was 240 per cent (absolute) with the Sensex at 9,959 on February 1, 2006. Rolling returns can be calculated over multiple time periods for different timeframes and averaged out. This gives a sense of returns and volatility.
There have been multiple bull and bear markets in the past 20 years. Using monthly data, there were 238 rolling returns of one-year between 1996 and end-October. Of these, 72 returns (30 per cent of returns) have been negative. An investor with a one-year timeframe would, therefore, lose money 30 per cent of the time. Even so, the average return for a one-year holding period is 14.8 per cent.
Returns tend to be even better for holding periods of five years plus. Using monthly data, there have been a total of 190 five-year rolling returns since 1996. Of these, 165 were positive, while only 25 (13 per cent) were negative. The averaged five-year rolling return was 103 per cent (absolute). That compounds to an annualised return of about 15.1 per cent for a five-year holding period. For a holding period of 10 years, there have been 130 rolling returns and all 130 are positive. The averaged absolute return for a ten-year “roller” is 319 per cent, which compounds to around 15.4 per cent per annum. So, the long-term investor gets both better returns and less volatility.
Investing in an index fund (or ETF) is among the easiest things to do. Is it worth pushing for even higher returns by looking at actively managed diversified equity funds? The data from India suggests that it is worth doing. The majority of actively managed Indian funds beat their benchmarks consistently. But the data from other markets suggests that actively managed funds are not such a good idea. The majority of actively managed funds in other markets underperform benchmarks.
Will India retain this exceptional flavour? It is unusual and it has persisted for a long time. There must be an underlying economic rationale. The most obvious explanation is that India is not a very efficient market. Hence, fund managers with access to management (and better information) have a big edge. Another possibility is that when funds take positions in relatively smaller stocks, prices go up sharply. These two explanations could both be correct at the same time. There may be other reasons too.
If you think this outperformance will continue, buy active funds with decent track records. Otherwise, buy index funds. If you fancy your stock picking skills, create your own portfolio. It is even possible to invest SIP-style by repeatedly buying the same stocks.
This is hard work but it is doable online for individuals. There is a payoff. It saves fund expenses and you receive any dividends payable. The gain on expense ratio alone is about 1.5 per cent. The Sensex has an average dividend yield of nearly 1.5 per cent. If you reinvest that excess, it is a big boost. There are some takeaways from the data. Equity is a must for good long-term returns. Longer the horizon, lower the risk. A third takeaway is for the fund industry: expense ratios are high, given an environment where the individual can replicate portfolios easily.
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
