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Buy and hold - The new mantra

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October 30, 2003 09:55 IST

There is a general sense of economic euphoria and enthusiasm in the air. Even seasoned observers are beginning to whisper that maybe India has tipped or crossed an inflection point and the corporate sector seems to be exuding confidence. The international community for once also seems to be waking up to India's potential.

In keeping with the times, the Indian stock market has also risen quite dramatically over the past six months, being among the best performing markets in Asia over this period. The rise of over 50 per cent caught most investors by surprise, with very few being actually positioned for it.

Now inevitably the attention and focus of most investors has turned towards figuring out when to sell. All the talk among seasoned India hands, both domestic and global, is about locking in profits.

From my limited knowledge about local mutual funds, I believe many have already begun selling, anticipating a significant market correction.

Historically this has always been the right strategy in India, for the market has basically done very little (in terms of index progress) over the last decade. We have had at least three market tops near 4,600(BSE Sensex), and one at 6,000 index levels.

More than this, in every single year, even intra-year, the market has always had quite wide swings in sentiment and performance over the last decade. Buy and hold as a strategy has been quite discredited in the Indian context at least in the minds of most professional investors.

It has always paid to take your profits in India after a rise of the magnitude just witnessed, as the market has invariably corrected sharply thereafter, giving you more than enough opportunity to re-enter at significantly lower levels.

The market correction each time has been caused by a different set of events or circumstances; a government collapse, the UTI debacle, market scandals, geo political tensions etc.

Whatever be the reason, the seeming sheer randomness of the events causing the correction and their unpredictability has given the Indian market the reputation of being one where you must take profits when you have them, as you never know what will hit you later.

Trading aggressively and taking quick profits has been the mantra of successful investors over the past decade but could things be different going forward? If one were to look at the extent of frustration on the part of most investors on their inability to participate fully in this rally, (only the few lonely souls who have held on to their stocks have really profited) the signs of change are already visible.

I for one think that things will be different this time around; there is a very reasonable chance that we are at the beginning of a sustained multi-year bull market in India.

All the signs are there; a decade of poor market performance, very cheap valuations, quality of corporate earnings, cash flows and balance sheets have never been better, and the growth outlook for corporate India never brighter. Despite this, there is still total disbelief in the possibility of this being a multi-year rise. People are scared to even contemplate the possibility.

Many Smart professionals (who should know better) and most individuals, still have the majority of their capital in fixed income funds with long bond yields at 5 per cent. These people will, I am sure, look back years later and wonder what they were doing.

The country is running a combined fiscal deficit of 10 per cent of GDP, has huge need for capital for infrastructure, interest rates are at all time lows, the economy is showing clear signs of acceleration, we are the low point of the corporate profits cycle, and yet they refuse to invest in a stock market trading at less than 13 times. Do they really think a 5 per cent interest rate will outperform equities over the coming decade?

Having been burned by the experience of the past decade and the inability of the market to sustain any rise beyond nine to 12 months, we have forgotten that serious bull markets of a secular kind tend to last years not months.

Every other major market in Asia has at some point had its version of a secular multi-year rise,why not India? If all the recent research highlighting the good long-term growth prospects of the country are even half right, then why can't we have many years of good markets in conjunction with strong economic growth?

The lack of institutional memory also compounds the problem and adds to the disbelief. The private sector fund management industry only really came into existence in 1993, and thus none of the senior fund managers or CIO's of today have any real experience managing money prior to this.

All they have seen is the dismal last decade, having cut their teeth during this period, it naturally seems to them to be the way the world always was and will be.

If however my hunch is right and this is the beginning of a secular bull market, then all rules change and what was appropriate investment behaviour over the last decade will only lead to under performance.

The secular bull market experienced by the US over the period 1982 to 1999 can serve as a good template of what to expect. I am not predicting an 18-year bull market for India, but still some lessons from the US are relevant.

Over this period, nearly 90 per cent of mutual funds underperformed the S&P 500 index (even accounting for a huge survivor bias). The lessons from this time are clear:

It pays to be fully invested at all times instead of trying to be cute and attempt market timing. The penalty of being wrong in your market call is so severe that being fully invested at all times is the only way to prevent guaranteed underperformance.

Focus on getting your long-term stock selection right, instead of worrying about whether stocks are overvalued from a quarterly perspective; try to identify winners from a multi-year perspective and sit on your core stocks.

Buy on any significant dip.

Raise your expectation of what constitutes a satisfactory return. The market may double over the next five years and within that many stocks will be five or ten baggers. Just because a stock is up 50 per cent doesn't make it an automatic candidate for sale, irrespective of long-term potential.

Running concentrated portfolios with low turnover will increasingly be the only way to outperform the benchmarks.

Indexation will gradually emerge as an industry as more and more funds find it difficult to consistently outperform their benchmarks.

Whether we are at the beginning of a secular bull market or not, only time will tell. If we are, then investors need to re-examine their investment styles and process. If one wants to take full advantage of the market, buying good companies and just sitting on them will by and large vastly outperform short-term trading strategies.

Investors need to rediscover patience, be more demanding in terms of returns and slower in pulling the trigger. Will there be corrections on the way? Of course that is part and parcel of markets. But hold on to your stocks for we just might have reached take off.

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