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Lesson Learnt

The last two months on the stock markets have been the best investing education that anyone could ever have had. It's been a great education in risk and return. These lessons will be valuable to those who learn from them

The last two months on the stock markets have been the best investing education that anyone could ever have had. Really, it's quite amazing that many of the basics of investing got hammered in as firmly as they did. Let's look at what we were taught. Back until April, the stock markets had entered a sort of an unrealzone. The markets were gaining rapidly and the Sensex was routinely delivering blockbuster days. Far more than the Sensex, for many small investors, the real action lay in the small and mid-cap stocks which were being talked up by operators and fixers of various types. There were plenty of these 'fixed price' deals around, and they were being presented as sure shots by brokers. It was obvious that those who were buying these stocks needed to understand that small-cap and mid-cap stocks are much riskier than large-cap stocks. This is a basic lesson in stock investing but one easy to ignore because some of these stocks rise much faster than the large caps too.

Of course, the markets fell. And then, they rose again. Sure, they rose hesitantly and continue to have hiccups, but the fact is that the big indices like the Sensex and the Nifty have recovered a good part of their losses. However, the mid-caps and the small-caps have behaved exactly as they are supposed to under these circumstances-they did much worse. To see how much worse have investors done, let us conduct a small experiment.

On May 10, the Sensex hit 12,612 points. On that day, the BSE Midcap index was at 6,033 and the BSE Smallcap index at 7,812. Let's rebase these two indices to 12,612 points and see where they went, that is, let's trace their future forward from that day as if they too had been at 12,627 points. This will give us a comparison to the Sensex that will be easy to comprehend.

This calculation is an eye-opener. On June 14, when the Sensex hit a low of 8,929 points, the rebased Midcap index was down to 7,729 points. After that, it has recovered, but only to 9,094 points, while the Sensex is up to 10,614 points (11th July). Predictably, the Smallcap index did much worse. The rebased Smallcap index fell to a low of 7,269 points and even after the subsequent recovery has managed to reach just 8,489 points.

Actually, the real story is even worse. The index is just an average, and one weighted by the size of the companies. Therefore, the numbers you see for the smaller indices are biased in favor of the larger among these. The smaller companies within these groups are far worse off. And these are just those companies that are at least worthy of being part of the indices.

When one looks at the universe of those BSE Stocks that were traded on the day when the markets hit the peak (about 2,400 companies), more than 500 are still down at least 40 per cent! 40 per cent down from its peak would have the Sensex at 7,500 points. So the 'personal Sensex' of those who have invested in these companies is currently below 7,500.

And while fund investors are not exempt-the more adventurous mid-cap funds are hit much harder than the large caps ones, its cheering to see that all except the worst equity funds have done better than the smaller indices. Of the 230 or so open-ended equity funds of assorted kinds, almost 200 have done better than the mid-cap index.

All in all, it's been a great education in risk and return. These lessons will be valuable to those who learn from them.