In survey after survey, an overwhelming majority of drivers (not just Indians but worldwide) claim that they have superior driving skills compared to the average driver. This over-confidence contributes to the accident rate!
The attitude of the active investor is similar. All active investors fancy their chances at beating Dalal Street in just the way that most drivers fancy that they are better than the guy in the next car. That overconfidence contributes significantly to retail investors being wiped out betting on stock-tips.
When an active investor takes a few hard knocks, his first reaction is to run for cover and exit equity forever. Only a small percentage will concede that they lack the time (never the skills!) to manage their own money. These rare 'realists' will seek to hand over their savings to somebody else, who can beat the street.
The mutual fund industry only picks up the savings of these rare few. This is why, despite four great years in succession for the Sensex, only 3.6 per cent of household savings is invested in equity mutual funds. That's a far lower percentage than seems natural in an economy where the household savings rate is near 35 per cent.
The fund industry faces some problems in holding onto and increasing its share of the savings pie. When it comes to indirect instruments, ULIPs claim a larger chunk of savings due to the aggressive marketing tactics of insurance companies. From 2008-09, more instruments such as real estate investment trusts will also be available. Properly structured, these are likely to be popular.
The fund industry must therefore, evolve to meet competition from external sources. Logically, it should not have a problem. Equity funds are better regulated and more transparent than ULIPs. Equity gives a broader exposure than REITs. Good fund managers can deliver returns far in excess of indices. The top 20 diversified equity funds all offered returns in excess of 80 per cent in the last 12 months when the Sensex returned about 47 per cent. Even index funds have returned over 44 per cent per annum in the past 5-years, dwarfing every other asset class.
But the mindset of the average investor has to change before the mutual fund industry can hope to get its fair share of assets. More Indians must graduate from being mindless traders of stock tips to committed long-term investors. In developed markets, pension plans such as the US 401K (which encourage investments through funds) help create a climate for long-term investment. India has a very tax-favourable environment for equity and equity fund investments - more so than most countries. But there is no "push" factor in the form of such forced investments for the service class.
The ideal fund investor is the sensible middle-class individual, who accepts a few realities. The first is that equity despite its apparent risks offers very good long-term rewards and hence, deserves a fair chunk of allocation. The second is that, the average individual is not going to beat the market unless he works full time at investing. The third is, most diversified equity funds will not beat the market consistently either but they will still give better returns than other avenues. Only somebody who accepts all these statements is likely to stay committed to systematic investment in the manner that offers the best chance at wealth creation.
Right now, very few Indians fit this profile of the unambitious, but discerning, passive investor. If 2008 turns into another bumper year for equity, there will be a few more converts. However, the fund industry could actually benefit from a sell off. This is not unlikely since earnings are clearly slowing down and political uncertainty looms large.
A crash in the Sensex would drive most retail investors (who are actually traders) out. A few discerning ones may seek shelter in good funds, which can deliver even in tough times. And of course, a decent fund will offer even better rewards to its long-term investors if the managers have the luxury of investing at better valuations.
Of course, a bear market makes it more difficult for anybody to deliver returns. But it would offer the best fund managers an opportunity to prove that they were indeed better than all the others. The National Defence Academy has a slogan: "When the going gets tough, the tough get going". Maybe the fund industry should cross its fingers, hope for a bear market and adopt that slogan?
This article was originally published on February 13, 2008.
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