Last week I wrote about how equity fund investors are getting more and more fretful about low equity returns. Since the second half of 2009, when the UPA returned to power and the equity markets were done with the sharp rally celebrating its return (how little did the markets know!), returns have been hard to come by. In that article, I'd said that four years is too short a time to be disappointed with equity and that a much longer time scale is needed to absorb the variability that is inherent in equity investments.
In response to what I wrote, I got a flood of responses, a good part of it angry, disbelieving or even downright derisory. I knew that the idea of long-term equity investing is now decidedly less popular among individual investors, but frankly I hadn't expected such sharp reactions. However, going beyond the depth of feeling that drives such reactions, it's instructive to analyse the logic that drives them.
Broadly, people believed one of two things. One, there were those simply railed against the idea that five years is not long enough. They want high and reasonably safe returns quickly and don't think that it's reasonable to expect anyone to hang around for a decade. And then there were the pessimists. These are the people who basically felt that the country was going to the dogs and even if long-term investing brought riches in the past, there were no guarantees that it would do so in the future.
Of the two, the first argument can be brushed off easily. This is the way things are in equity investing. You can either live with it or not invest. Equity is prone to extreme swings around its mean progress. If you catch the peak on the way in and a trough on the way out, then there' nothing you can do. And that is exactly why every sensible approach to investing recommends cost-averaging, which in funds means investing through a Systematic Investment Plan. If possible, even the exit from an investment must be done by averaging the price over a period.
The second argument, as I said, is more interesting. What if it's different from now on? That for many more years to come, equity markets will either decline or meander along around the same levels. Some people will get lucky some of the time with their stock selection but a diversified multi-cap investor or an index investor will get nowhere. Again, there are no guarantees. Despite what the mandatory disclaimers say, the future has no obligation to resemble the past. Things could indeed get much worse for a very long period of time. The kind of deep-set despair that one sees among business leaders and large chunks of the Indian middle has no parallel since 1990--and that was almost a quarter century ago.
However, even if such a thing were to come pass, you'll be better off invested in equity rather than in fixed income of some kind. At a basic level, one can expect that over time businesses will generate more return than their cost of borrowing, otherwise it doesn't make sense to be in business. Individual businesses will do worse, but as a whole, Indian businesses will deliver a return higher than fixed income returns over time. There could be caveats here too. Would this return on capital translate to actual gains for equity investors? Again, based on the way things have gone in the last quarter century, one would be correct in expecting it to. But is that a guarantee? No, it isn't.
At the end of the day, anyone who is analysing investments and advising people has no tool except basic principles applied to past events. That goes any distance only if the future has a resemblance to the past. If you don't believe in that, then you're on your own.
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