Equity – a concern or an opportunity

Off late investors are concerned about the basis of continuing the allocation to equity, even for their long term goals like retirement, child education or marriage which are more than ten years away. For the last few years the news headlines speak only about volatility or some new challenges on the economic front like the worsening fiscal deficit, scams involving cabinet ministers, the Euro zone crisis or lately the labour issue at Maruti Suzuki plant at Manesar.

Rightly so, since the performance of equity, as an asset class has gone nowhere for the last four years throwing serious doubts in the minds of investors at large about its ability to deliver returns, with hardly any signs of revival. At the same time other asset classes like fixed income securities (fixed deposits), real estate and gold have either provided stability or have given better returns or both compared to equity.

Come September, and the chain of announcements on the reform front – the raising of foreign direct investments in retail sector, followed by some announcements for the insurance and pension sectors and the introduction of the new Companies Bill. As a result the equities started looking northwards and on the first signs of revival, lot of investors (sitting on the fence) change tracks and switch to avenues like fixed deposits or gold for not being left out of the growth story of gold or into fixed deposits to stay away from volatility.equity

The comparison between assets happens with respect to returns and the stability factors. To understand more about this we need to understand the behaviour of the assets, one after the other:

Fixed Deposits:

Fixed deposit is a certain investment avenue;

  1. It provides a fixed return,
  2. Is available for a fixed term and
  3. Lastly, it provides a fixed amount at maturity.

However one needs to understand that:

  1. Interest rates are volatile – i.e. interest rates move up or down in line with inflation, which has gone up  due to various factors like high food & crude prices, rise in the government borrowings to bridge the deficit figures due to rising subsidies burden etc.
  2. The real returns – differs since one needs to calculate returns after inflation and taxes? Real returns have been negative for quite sometime now, reducing the purchasing power of the rupee. Eg. The minimum auto fare in Mumbai has increased from rupees twelve to rupees fifteen, a twenty five per cent jump in two years or say twelve percent per annum. Do fixed deposits pay so much?
  3. The credit risk is very important. Sometimes the greed to earn more interest can come at the cost of the principal amount especially when the bank or company is not in a good shape it tempts investors with higher rate of interest. A good example is Ceat Finance, a Ceat Tyre group company where in deposit holders lost large part of their capital.

 Gold

Gold for one, a crisis asset has performed extremely well since 2005, with the first signs of the weakness in the US economy, which resulted in some of its largest and oldest financial institutions like Lehman Brothers going burst.

  1.  Gold is a good hedge against inflation and a common currency in extreme situations like war.
  2. However it does not generate any income like rent, interest or dividend.
  3. A good crises asset (but hardly sold during a crisis).

Real Estate

On similar lines real estate a growth asset, has been on an upward ride in India, for the last eight years, after losing over fifty percent from its previous peak in mid nineties. Historically it is believed that this asset class has always given great returns, however there are positives and negatives. Just to name a few:

  1.  It is tangible and there is a strong touch and feel factor, possessiveness as opposed to equity investments.
  2. The commitment is big and most of the times it comes with a standard 15- 20 years baggage of home loans adding pressure during difficult times.
  3. The cycles continue for longer periods as seen in the fall of mid nineties till 2003 and the rise from 2004 till date.

Equity

Equity on the other hand can be a non performer for a long period as is evident for quite sometime now. And that is its strongest selling point today for various reasons like –

  1.  Earnings of many of the blue-chip companies have more than doubled during the last four years.
  2. Risk of the prices going further down (as per historic data) is low, i.e. it is the cheapest asset today.
  3. Returns – it being a growth asset, has the ability to generate real returns after considering inflation. BSE index has delivered 17% compounded over 32 years of its existence.
  4. Investments – smaller amounts compared to the other growth asset like real estate.
  5. Liquidity –is pretty high since it has an organised market with a wide reach.
  6. Regulated – one of the most regulated asset class.
  7. Partnership – it provides the opportunity to invest in businesses run by industry stalwarts like the Tatas, Birlas etc.
  8. Professional Help – Lastly through Mutual Funds it provides the best of professional support to guide equity investments of the people at large.

To sum up and to re-emphasise that equity as an asset class, has over longer periods delivered inflation proof returns besides all the turmoils, as reflected by the BSE Sensex which was established in 1980 at 100 is today in October 2012 at approx. 18500 or 185 times.

However one can benefit only if one chooses to stick by the investment decision and holds on during bad times.