Pandemic lessons: Long term equity investment

 

This one ended happily:

One day in July 2019, a friend asked me to help her with an investment problem. We discussed her financial position; which was strong and stable. She didn’t need the money then or ever. Initially, I proposed a 100 pc illiquid structure: 50 pc equity and 50 pc corporate debt. But she demurred and wanted some portion liquid. So, we agreed on 10 pc liyquid and 90 pc illiquid division. We also agreed to divide the illiquid portion equally between debt and equity. She chose fixed deposits for liquid investment and I chose NPS for illiquid investment. Money got invested.

NPS-National Pension System- is a regulated entity, its products are illiquid until 60 years of age. It is famed for its low expense structure and easy online investment and monitoring facilities. It also allows you to redistribute your money -once a year- between equity and debt, ranging from 0 pc to 100 pc.

Hardly one week had passed, when she began hassling me. Though she had agreed for equity investment, but in reality, she feared all would be lost. Soon she moved out the equity portion to make allocation 100 pc debt. Time passed.

The year 2020 started, everyone got anxious about pandemic and prices of equity securities went down. Her decision got vindicated. Sometime in April 2020, I asked her if she was agreeable to invest a small portion to equity again. She agreed to move 25 pc money to equity.  Soon prices went up and  value of equity which was one-third of debt grew to be one-half. Once new financial year set in April 2021, she changed back to 100 pc debt. Her return was 17 pc p.a. She was good.

We calculated what would have happened if we had adopted buy and hold strategy i.e., initial allocation of 50 pc equity were continued, her return would have been 14 pc- an adverse performance of 3 pc with double the exposure to equity. Next, we calculated if the second allocation of 100 pc debt were continued, she would have got 8 pc-an adverse performance of 9 pc. The buy and hold strategy wouldn’t have worked in either case.

Finally, we speculated what if she keeps her investment for 20 years and catches another catastrophe in similar fashion in 2031. If that happens, it will result in an additional 21 pc redemption amount in 2039 over ‘all debt all the time’ portfolio. In other words, one crore of initial investment will fetch eighty-eight lakh additional redemption amount on account of ‘catastrophe’ equity investment. One crore is ten million and one lakh is one hundred thousand.

The paradox of equity investment is fearful people stand the best chance to benefit from it. These are not those people who stand by the sideline and wait anxiously to get in, but those people who can’t be persuaded to come in until a global catastrophe comes knocking their door and rush out as soon as they can.

 But this one didn’t:

One day in April 2020, I got an urgent call from another friend, who was worried about covid: there were reports insurance companies declining to cover covid expenses for their customers. He was also worried about media reports describing job losses and pay cuts.

He had invested in 3 equity mutual funds: 70 pc in active funds and 30 pc in passive fund. The active funds were equally divided between two funds and the passive fund was in Nifty companies. Nifty is a benchmark Indian index, which consists of 50 largest capitalized companies. The investments were made over last 10 years: systematic monthly investment for 48 months and the balance were made at irregular periods. He held a health policy of 2 million rupees and had a cash reserve worth 10 years of routine expenses. He argued he could manage a job loss for a while, but felt vulnerable on health front due to novelty of the disease.

After much deliberation, we agreed to sell one active fund, switch out the other active fund to passive Nifty fund, and to continue with the original Nifty fund. We reasoned that large corporations would recover fastest, which justified the change to Nifty fund.

The sale of 35 pc of holding assuaged his health fear. But less than 1 pc return made him miserable. Once prices went higher, he sold his original nifty fund to get 9 pc return and in April 21-one year from switch out date- he sold the last fund to get 7 pc return. It was all very confusing. So, in order to get a better sense of his equity investments, we combined all cash flows and the overall return came out to be a paltry 6 pc. Considering high inflation numbers in India, it was an unacceptable return for investment made over 10 years. He was disappointed.

The truth is future needs are unpredictable. And many of them will rise in tandem, when conditions will be terrible. Those won’t be irrational fears but real human needs, which won’t be banished easily. The strategy of “buy, hold and sell when need arises” will expose you to harms. So, sale decisions must be strictly performance based and must never be need-based. Though investment companies never tire off selling need-based solutions.

True, this is just one case I know of and there is not much information available how people fare in their equity investments. I wish investment companies advertised median redemption yield rather than mechanical, unhuman NAV returns.