My foray into equity investing began in 2007 with an investment in an equity linked saving scheme (ELSS). With a bull market raging,a large number of mutual fund schemes then showed three- and five-year compounded annual returns ranging from 30-50 per cent. Things were hunky-dory till January 2008 when the market meltdown began. Since then the returns from my ELSS have turned anaemic. To add insult to injury,the scheme has tumbled out of the ranks of the top-five taxsaver funds. I have stopped my SIPs in that fund and shifted to another that is currently ranked among the top five. But I often wonder: how long will it be before this fund too loses its pre-eminent ranking? Meanwhile,my money remains locked for the stipulated three years in that first,poorly-performing fund. The next step in my evolution as an investor happened as follows. Actively managed funds,I learned,are fickle: the star fund manager who fetched those stellar returns could one day pack his bags and leave for another fund house; the market may no longer favour the fund managers investment style; or,being human,he could simply commit a series of errors. The answer,I learned,lay in investing in passive funds index funds or exchange traded funds. Their charges are much lower and there is no fund manager involved. And experience in the US market suggests that three-fourth of actively managed funds underperform the index in the long run. I felt I had cracked the magic code of investing and was on the road to riches. Alas,this state of bliss lasted barely a year. A new book by Parag Parikh Value Investing and Behavioural Finance (the author runs his own financial advisory firm in Mumbai) has destroyed my equanimity. Parikh argues that the most important criterion for a stock making its way into the index is high market capitalisation (which is usually the result of the stock being priced high). In other words,he says,when you invest in an index,you buy a basket of expensive stocks,thus violating the most important tenet of value investing: the returns you earn from a stock are a function of its purchase price; higher the purchase price,lower the returns. When you buy the index,your returns are bound to be sub-optimal,says Parikh. His logic appears hard to refute. Parikh substantiates his argument with empirical evidence. He ran a study on the BSE Sensex for the period between 1979 and 2005 for which he constituted two portfolios: one comprising stocks that entered the Sensex during this period and another comprising stocks that went out of the Sensex when the replacement happened (we shall refer to the latter as laggards). All dividend was reinvested and rights issues bought. Returns were calculated from the day the replacement took place. Parikh found that the portfolio comprising the laggards roundly beat the portfolio comprising the incumbents (stocks that entered the index). The trouble with index investing,says Parikh,is that there is no way to benchmark the performance of the index (since the index is itself the benchmark). Whatever the returns from the index,the investor accepts them without question,since he has got the market rate of return. This leaves one in a dilemma: if the bulk of fund managers underperform the index,and the index itself is a sub-optimal performer,where should one (who cant or doesnt do his own stock-picking) invest? Perhaps adopt Parikhs de-indexing strategy. The trouble with IPOs All of us like new things: new clothes,a new car,a new house,and whatever else new that money can buy. Our fascination for things new can,however,spell trouble when extended to the stock market. Most initial public offers (IPOs),says Parikh,come to the market during a bull phase. Thats when greed overpowers fear and investors are willing to pay a high price for stocks. In such times,promoters can get the best price for their stakes. Many IPOs also belong to what is perceived to be a hot sector like real estate,infrastructure and power during the last bull run in 2006-07. Its a myth,says Parikh,that IPOs are inexpensively priced; those days ended with the abolition of the Controller of Capital Issues. Nowadays promoters and their advisers (investment bankers) peg IPOs at the maximum price they believe the market will be willing to pay. If,despite the high pricing,IPOs soar on the day of listing,that is evidence of excessive investor exuberance and not of promoters magnanimity. The only time IPOs are priced at a bargain is during a bear phase (the most famous example being Infosys). Again,since investors buy IPOs at high prices,the returns they earn from them tend to be poor. The biggest losers in an IPO mania are investors who,having failed to get an allotment,buy the IPO on the day of listing. If the stock appreciates on listing,it becomes more expensive still,and investors returns are hit harder. After a few months go by,the IPO stock loses its sheen of novelty and its price comes crashing back to terra firma. The bottomline: the probability of losses from an IPO far exceeds the probability of gains. With so many IPOs slated to hit the markets in the coming months,investors would do well to remember Parikhs advice. Since most of us learn how to invest from foreign books (the staple fare comprising books by Benjamin Graham,Peter Lynch,Burton Malkiel,Robert Hagstrom,and so on),this one by an eminent Indian money manager comes as a godsend,since the examples and the context are both Indian. The book offers a wealth of wisdom and insight on the Indian markets. It is also an intellectually honest and courageous book (read the authors critique of the Reliance Power IPO). My only quibble is with the quality of editing,which,I believe,could have been better. Read this tome and imbibe its lessons,especially those relating to ones own behavioural weaknesses: it will save you a fortune in money lost on the bourses the price that novice investors who enter the market without any intellectual preparation inevitably pay. u sk.singh@expressindia.com
