It’s different this time. That phrase has long been the butt of jokes as well as the subject matter of aphorisms in the literature of investing. Whenever the investment markets are unusually healthy, there’s no shortage of optimists trying to prove that they’ll keep going up because, you know, it’s different this time. They use that phrase to point out that the normal rules of caution shouldn’t apply. At the same time, there’s no shortage of realists (in which group I count myself) pointing out that the appearance of this phrase itself as a warning sign.
But it’s different this time. I mean the circumstances of using the phrase ‘it’s different this time’ are themselves different. This time around, everything about the financial and investment markets looks different from what it’s supposed to be. However, the direction if opposite and it’s the pessimists who are pointing out that things are different.
Departures from the normal are sometimes hard to recognise, but for Indian investors they have become so widespread that they are now hard to ignore. In mutual fund investments, which is what I track closely, practically every asset class is now has a strange anomaly at its heart.
Equity hasn’t turned in any decent returns for four years. Generally, even conservative advisors would say that investing in equity for above three years is safe. Today, this period could get extended indefinitely. Even more strangely, in recent market declines, mid-cap funds have fared better than large cap funds. This is the reverse of what is supposed to happen. From an investment perspective, one major difference between large-cap stocks and mid-cap stocks is supposed to be that large-caps are safer. When the markets weaken, large-caps are expected to decline less and hot mid-caps more. In declines, investors rush to sell mid-caps in large numbers, precipitating a decline. Thus, large-caps are said to be more defensive in bad times. This principle appears comprehensively violated in India in recent times.
Debt funds have their own anomaly. Generally, debt funds adhere to the pattern of the shorter term funds having the least (and the most stable returns) while the longer term funds varying according to the current interest rate outlook. However, in actual practice, there has recently been an almost complete convergence of returns between maturities of widely different time horizons. From ultra-short term funds to what are supposed to be longer-term income funds, everything gives a return of around 8 per cent a year, give or take a little. More pertinently, every type of debt fund have maturity and risk profiles within a very tight band.
Moreover, the only type of fund that appears to have got investors excited are gold funds; but of course, these are not really mutual funds at all, but merely more convenient ways of buying gold. It's the Diwali and Dhan Teras fund category, which now has nothing to do with the world of investment management in any conventional sense.
So, things are different, right? Well, not quite. When we examine each of these phenomena in isolation, things do seem to awry. However, each of these are actually transient situations. Let's take them one by one. Equities in general may not have been rising for four years, but they are certainly getting more and more attractive. Despite all sorts of gloom and doom and fits and starts, companies top-lines and bottom-lines are better than when the markets were last at current levels. If one isolates the handful of problem industries and business groups (real estate and ADAG being the foremost examples), things haven't gone so badly.
As for large-caps declining more than mid-caps, that's an inevitable side effect of the way FIIs invest in India. Most FIIs invest only in big companies. They have a small positive list, sometimes limited just to Sensex-Nifty companies and they won't step outside that. This is fine in normal times but when there's panic selling by FIIs, large-caps tend to fall more than mid-caps because FIIs hardly own any mid-cap stocks.This has nothing to do with the inherent long-term stability of larger companies. In a way this is a sort of a circular impact—the negative comes out of the FIIs' wish to avoid negatives, but it's something that just has to be expected. In the medium and the long-term, it just has to put up with.
As far as the flatness and the lack of choice in debt funds is a side effect of the unusually predictable phase that the interest rate situation has been going through. Normally, there's an ebb and flow of money in and out of different types of funds as interest rates shift. There's also a normal distribution of the different outlooks that different fund managers have. But the sheer predictability of the interest rate scenario has put paid to all that. Every bond investor and bond fund manager has the same view of what's going to happen and so far they've been right. The result is that over time, a large proportion of debt funds have become clones of each other. Once the predictability vanishes, so will this sameness. It's just a matter of time.
Still, I guess one should be grateful for whatever little bit of unpredictability that is there, no matter where. We definitely need some antidotes to the flood of uncertainty that blows our way daily from Europe. I won't pretend to say anything about the European situation because there will be a few days between my writing and your reading this. The way things are, even a gap of hours is too much.
However, as a realistic investor, I'd be confident of one thing—it's not different this time. There's a lot of light and sound appearance of action, but one way or another, normalcy will assert itself. Equities will stay the best long-term asset class, large-caps will be more stable than mid-caps, and the sun will rise in the east.
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