Long-Term Investing :The Key To Success!

Everyone involved in the stock market game will agree that investing benefits only if it is done for the long term. However, on the practical side, very few investors display the patience required for long-term investing. Yogesh Supekar discusses the merits of investing for the long term while Shreya Chaware highlights the rewards one can expect to receive by staying invested for such extended durations.

The stock market is a funny game where we see investors bullish when the prices are soaring (expensive) and usually the same pack of investors get bearish when the stock prices are trending downwards (cheap). Says Sachin Rane, a mutual fund advisor and distributor from a Tier II city: “Recently when the stock market was trending upwards, all investors wanted to buy Poonawalla Fincorp when it was available at about Rs 302 per share. However, now that the markets have corrected and the sentiment has reversed, the same stock is available at about Rs 240 per share which is 20 per cent cheaper from its 52-week highs. Logically, one should be buying the product if you are getting it cheaper, right? But that is not how things work in the stock market.”

Indeed, the concept of ‘right time to buy’ is one of the biggest scandals the stock markets have ever seen. The truth is there is never a right time to buy unless one is willing to wait for the ‘right amount of time’ in the markets. However, most investors are always obsessed with timing the market. It is a known fact that most investors are short-sighted when it comes to the stock market game which is designed for winning in the long run. It is only after an investor spends years in the stock market that he or she realises the merits of long-term investing. It may not be completely wrong to say that most investors are forced to be long-term investors just because their short-term positions have gone against them and that they failed to apply stop losses in their positions.

Failure to book losses in the short-term trades facilitates the investor to conveniently call themselves long-term investors. What then is an ideal ‘long term’ when it comes to investing in the equity markets? Also, haven’t we seen that long-term investing in a poor quality stock tends to destroy wealth? Before talking about the huge benefits of long-term investing which may only be fructified after remaining invested for several years, it may be wise to also have a cursory glance at those stocks that failed to recover even if an investor was willing to wait for a decade or so.

We find that there are at least 563 stocks that have gone nowhere and have actually destroyed wealth over a period of the past 10 years. In other words, remaining invested in these 563 stocks even for a long term i.e. 10 years has not proven to be profitable. Some of the stocks that fall in this list of wealth destroyers include popular stocks such as Bank of Baroda, NMDC, Coal India, BHEL, Canara Bank, ONGC, NTPC, SAIL, Jindal Saw, Jain Irrigation, etc.

Clearly enough, the table above explains that long-term investing in itself does not guarantee success in the equity market. It is the combination of being a long-term investor and investing in right quality stocks that will fetch you the desired results. You remove any of the above two elements in investing and chances are that you may never achieve the desired results from your investments in the equity markets. In other words, holding high-quality stocks for the short term and holding poor quality stocks for the long term will always lead to sub-optimal performance in the markets.

Defining Long-Term Investing
Technically for taxation purpose, the long term is defined as any financial investment made with a one year-plus view. Hence, long term is always considered as a one year-plus investment horizon. But long-term investing goes beyond this simple definition. It does not simply mean to buy stocks and hold them forever or at least for one year. Long-term investing is an active exercise of managing the portfolio of equity for considerable amount of time – running into several years and definitely more than one year. Long-term investing involves chalking out a plan – an investment strategy. Long-term investing also involves actively churning the portfolio unlike the common perception of passive ‘buy and hold’ strategy.

Investing in equity markets is easy and extremely rewarding if you have a clear idea of what you are doing and are equipped with the right resources to succeed in the markets. The right resources can be adequate capital, right stock advisor, the right temperament to succeed in the markets and most importantly, the willingness to remain invested for a long term.

Getting rid of underperformers is also an important aspect of long-term investing while the trick is to hold on to the winners. For all practical reasons, staying invested for at least five years sounds reasonable as such a period is good enough for the markets to recover just in case there is a contingent event such as Brexit, demonetization, the pandemic or a geopolitical situation like the ongoing war between Russia and Ukraine. Thus, long-term investing is the active management of a portfolio where a restructuring of the portfolio and rebalancing of the portfolio is done on a regular basis. Long-term investing is a combination of strategic management of portfolio as well as tactical portfolio management.

If one were simply to trade for the short term and never hold any stocks for more than a year, how would it be possible to experience a multibagger in the portfolio? Also, any investor not practicing long-term investing principles is plainly denied the rewards of the ‘power of compounding’. The power of compounding works by growing your wealth exponentially. It adds the profit earned back to the principal amount and then reinvests the entire sum to accelerate the profit earning process.

Strategic Portfolio Management versus Tactical Portfolio Management

Financial consultants or portfolio managers determine the overall risk tolerance and objectives to determine an appropriate asset allocation. After the allocation is determined, portfolio managers distribute the capital both strategically and tactically to invest with a focus on what is best for each individual client. So, you might be wondering, what’s the difference? 

Strategic Asset Allocation
Strategic asset allocation works with the aim to construct ‘efficient’ portfolios. Efficient portfolios are the ones which maintain optimal mix between different asset classes, namely, stocks, bonds and cash, with a focus on maximising returns for a particular level of risk. The strategic asset allocation approach involves holding on to original allocation over long periods of time, generally spanning a decade or more. After establishing long-term strategic allocation targets, investors will need to periodically rebalance portfolio weightings back to those target allocations.

Let us understand the same with an example. An investor establishes a strategic asset allocation target of 60 per cent stocks and 30 per cent fixed income. After a particularly strong year for the stock market, the allocation to stocks has risen to 70 per cent and fixed income allocation lowers to 30 per cent. According to the strategic asset allocation approach, the investor would reduce the stock allocation from 70 per cent down to the strategic target of 60 per cent and utilise the sale proceeds to advance the fixed income allocation back to 40 per cent of the portfolio.

To keep investors inclined towards the right direction for the long-term, appropriate asset allocation plays an important role. Strategic asset allocation underlines a framework for an investor’s portfolio by appropriately aligning the asset mix with long-term investment goals and objectives. Strategic asset allocation can be challenging in volatile market environments as rebalancing allocations back to strategic targets may lead to buying stocks in periods of market stress and economic uncertainty.

Tactical Asset Allocation
Tactical asset allocation establishes a baseline mix of assets that are suitable for an investor’s risk tolerance and investment objectives. Instead of merely deciding on an asset mix and following the same, the portfolio weightings will be adjusted actively based on short or medium-term expectations for economic conditions, valuations, market cycles, etc. This approach holds potential to amplify returns, lower portfolio risk and increase diversification which count as important benefits of the same. These tactical allocation changes or shifts are taken into account and implemented with the goal of generating superior risk-adjusted returns in comparison to the otherwise strategic asset allocation approach.

To explain the same with an example, an investor decides to reduce the allocation to domestic stocks to below normal or strategic allocation levels and increase weightage to international equities on the back of favourable short or mediumterm view of international stocks. This constitutes tactical asset allocation based on future market view. The tactical asset allocation process is named as a success if the tactical investment decisions achieve the goals of generating superior risk-adjusted returns compared to a strategic asset allocation approach in reality.

It should be noted that we have witnessed at least 148 stocks that have turned out to be 100 baggers since 2020. This means that are at least 148 stocks that turned investors’ Rs 1,00,000 into Rs 10,000,000 or more if the said sum was invested in any of these 148 stocks in the year 2000. We have at least 645 stocks that multiplied by 10 times in its value since the beginning of the year 2000 and these values are in spite of the current deep correction in the markets where we have seen the stocks drop by anywhere between 10 per cent to 60 per cent in value per share. Thus, invest for long-term if you want to experience the power of compounding. Another strong reason behind long-term investing is the fact that volatility gets normalised and the chances of negative returns for the portfolio reduce drastically as we increase the tenure of our investment horizon. 

INTERVIEW

Mrinal Singh
CEO and CIO, InCred Asset Management

The Indian Economy Looks Robust From A Long-Term Perspective

The markets have experienced a decent correction over the last few weeks mainly due to aggravating geopolitical tensions among Russia and Ukraine. What is your overall assessment of the current market scenario?

Such crises in the past have stemmed the financial market. They have been both the causes and effects of the underlying trends that have driven global affairs over the last two decades. One event that shook the modern world and had a sharp impact on financial markets, as well as global stability, was the September 11 attacks and the ensuing response. Similarly, the war in Kargil, the US-China trade war and the attack on the WTC have all had a severe impact on the financial markets and have created periods of extreme fear and uncertainty. Russia’s attack on Ukraine has created further global insecurity and uncertainty. However, one should always look at the performance in the long run. Thus, it would be relatively best to focus on those sectors in India whose growth may not be as affected by global upheavals.

Amid the ongoing Russia-Ukraine crisis, Brent crude oil prices have breached the USD 111 mark, touching nearly an eightyear high. Will this hamper the growth prospect for companies over the next few quarters? Which sectors appear vulnerable to you?

Let’s understand it this way: the pump prices increase by Rs 5 per litre for every USD 10 per barrel rise in crude oil price if fully passed through. To offset this surge in prices the excise duty needs to be cut which eventually will lead to lesser excise collection and impact the government finances in terms of loss of revenue. The global oil supply could likely remain restrained in the near term with the Organization of the Petroleum Exporting Countries (OPEC) producing well below its production targets and the US production remaining range-bound.

It is likely to remain volatile if the ongoing geopolitical conflict does not materially ease. Given India is highly dependent on oil imports, such a steep rise in oil prices can be a concern with respect to inflation, current account deficit (CAD), corporate profitability and currency. In any case, we are able to fund our crude or energy inputs through our IT exports. In the last 20 odd years, for the first time our IT exports are in excess of USD 150 billion for this fiscal, which is sufficient to provide for our energy imports, comprising crude to a large extent.

In the near term, high oil prices will push up inflation because crude is imported and it also has an effect on crude derivatives which are in terms of chemicals or petroleum products of various orders. Sectors such as paint, chemicals, oil marketing companies, aviation and cement are some of the vulnerable sectors. In the era that we are in today, the future is clearly green. The source of energy generation would be more environmentally compliant. Higher fossil fuel prices may make those business cases more viable.

What are the most promising investment themes you would like to bet on over the next 8-10 years?

It is important to note that the Indian economy looks robust from a long-term perspective and if you are looking to build robust long-term portfolios then you must treat this volatility and period of turbulence as an opportunity to invest in excellent companies and themes at compelling valuations. We are clearly seeing that the economy or a section of corporate India has walked into the capital expansion mode. IMF says our per capita income is something like USD 2,200 and by FY25 they estimate that we would cross USD 3,000 and by 2030 we would cross USD 4,700. The important point is the transition from USD 2,000 to USD 3,000. Sectors related to spending on individual mobility, education, leisure, travel, entertainment and consumer durables will contribute to this journey.

To reiterate, the outlook for the Indian economy is quite robust. We see potential, particularly in segments that are driven by capacity expansion. Our propositions are more inclined towards domestic manufacturing and capacity addition with the participation of sectors that are going to meaningfully participate in the China Plus One movement. However, there could be an addition to that area such as textiles, chemicals, engineering boards, automobiles as well as sectors aligned to a greener future of the economy. We believe even housing and the mortgage space looks appealing. 

The probability of a well-diversified portfolio to deliver negative returns is almost zero in case the holding period is extended to more than 10 years. Several extremely negative conditions have tested the resolves of the markets in the past. We have had wars and then we have had natural calamities impacting the market conditions. The most recent example has been that of the corona virus pandemic in the course of which the global equity markets tanked by nearly 40 odd per cent, only managing to recover 100 per cent of the losses in 8-9 months. The table below highlights recovery in the markets post the outbreak of wars across the globe:

Why Long-Term Investments is key?
If we consider the performance of the BSE 500 constituent for the period between 2000 and 2015, we find that the returns any investor would have achieved on investments are far more superior. But only if one were to remain invested for at least 5 years versus the returns achieved for the holding period of one year.

To understand the behaviour of returns and holding periods, we have simply observed the performance of BSE 500 constituents from the beginning of the year 2000 till 2015. The below table summarises the average performance on BSE 500 constituents across various holding periods i.e 1 year, 3 years and 5 years throughout 2000 till 2015. 

It is not just the returns that improve as the holding period increases, but also the breadth is significantly better when one is willing to hold for 5 years at least.

We find that at least 77.8 per cent of all the stocks when considered for their performance over 2000 to 2015, for a holding period of at least 5 years, delivered positive results and only 17.87 per cent of the BSE 500 constituents have delivered negative returns in the same period. The percentage of stocks with negative returns however increases drastically when we consider the holding period of only one year for investments from 2000 to 2015 on a rolling basis. The percentage of stocks that delivered negative returns is more than double when one chooses to invest for one year when compared to a period of 5 years.

This goes to suggest that the risk-reward ratio is in favour of the long term investors with an investment horizon of 5 years when compared to an investment horizon of 1 year. It is not only that the returns are magnified for holding stocks for 5 years, but also the probability of stocks delivering negative returns reduces drastically.

Why Are FIIs Selling in India?
The biggest fallout of the ongoing war between Russia and Ukraine is the rising crude oil prices. The crude oil prices are trading well above the important psychological mark of USD 100, which was simply unthinkable about at the beginning of 2022. What the sustainable rise in crude oil prices does is that it impacts the fortune of Indian economy more adversely than most economies. Hence, it may not be an exaggeration to say that the India could be the worst hit economies amongst all the large economies because of the current Russia- Ukraine war. The current inflation rate of India has increased to 6.01 per cent in January whereas the wholesale price index is at 12.96 per cent and is at the two-digit mark since April 2021.

India imports nearly 85 per cent of its total crude oil consumption every year. The country imports about 290 million tonnes of oil in a year. India is the third-largest consumer of oil at 5.35 million barrels per day (MBPD) behind US (21.2 MBPD) and China (15.1 MBPD). India’s own oil production has been below 7,00,000 barrels per day for a long time. According to Nomura’s research, a 10 per cent increase in crude prices leads to 0.2 basis point reduction in GDP growth. The Economic Survey 2022-23 has estimated GDP growth of 8-8.5 per cent. However, the projected GDP growth for the forthcoming fiscal is based on oil price projection of USD 70-75 per barrel range.

Assuming that oil prices are at USD 75 per barrel (last year), then India’s oil import bill is approximately USD 165 billion. Besides, India exports refined petroleum products as well. At USD 75 per barrel oil price those exports would amount to USD 58 billion which will convert the oil trade deficit to USD 105 billion.

India’s import share for oil from Russia is under 2 per cent, which is hardly a significant number, but India is dependent on Russia for defence arms support.

However, according to the global scenario, the prices of crude oil are now around USD 100 per barrel. So, when the oil prices are at USD 100 per barrel, India’s oil trade deficit (imports-exports) would be around USD 140 billion.

Hence, for every USD 10 rise in crude oil from say USD 100, India’s oil trade deficit will rise by about USD 15 billion. For instance, at USD 120 oil price it would be about USD 170 billion. India’s ex-oil goods trade deficit at the current run rate is likely to be about USD 100 billion. At USD 100 oil price, USD 140 billion will be added to the trade deficit which totals USD 240 billion. This is a large deficit number for oil itself.

But for the impact to affect the numbers and change its course in the balance of payments, the oil price has to be more than USD 100 for a minimum of 12 months. The other vital area of oil price impact is going to be inflation. For every USD 10 rise in oil it adds 90 bps to wholesale inflation and about 25 bps to consumer inflation in India over a 12-month period. Now, if in case oil prices trade above USD 100 for a few weeks and return back to the pre-conflict levels of USD 90, India’s balance of payments will have minimal impact.

But if oil stays above USD 100 or say USD 120 for even three months or more, India’s external situation will deteriorate, leading to higher inflation, interest rates and rupee depreciation. FIIs are selling Indian equities at record pace because there is a fear of depreciating rupee, worsening economic macroeconomic conditions (trade deficit) and rising inflation. Rising inflation may lead to rising interest rates and that is definitely not a good sign for the equity markets. 

Conclusion
Good news and good prices don’t come together. However, a crisis situation almost always guarantees a good price for risky assets such as equity. Historically, the markets have gone up post crisis situations. As far as the current crisis goes, in all likelihood the situation may get worse before it stabilises for the equity markets. However, investors do not have to simply deal with the geopolitical situation alone as the bigger problem in terms of the rising inflation and expected increase in interest rates in the coming months provide a clear headwind for the markets. The rise in commodity prices could hurt the profit margins more than previously estimated. As the situation is murkier than most investors would have liked it to be, it makes sense to stay away from stocks and sectors where the rise in crude oil prices is expected to impact the fortunes of the companies and the sectors adversely. Paint companies are just an example of how the rising crude oil prices may impact them negatively. When it comes to the equity market in times such as now where the volatility is rising, defensives can be preferred over other sector stocks. Also, some amount of cash can be held and there should be no hurry to buy at the dips in the current market situation.

While there is no doubt that the markets will rally once the war stops, it is very difficult to say if all the stocks may recover. Some of them may not recover from the current fall as the dynamics may not allow some of the weaker companies to survive. Hence, betting on the strongest of the stocks is the only way to deal with the current market situation. FIIs have sold to the tune of Rs 2 lakh crore since the beginning of October. The trend of FII selling may continue and hence the stocks may trade with pessimism in the coming weeks as well.

With no signs of trend reversal in sight, investors ought to be extremely careful in the coming week. The market needs the war to end and also the crude oil prices to trade below USD 100 per barrel consistently. Looking at the fragile market condition right now, it is important to enter the markets with a long-term investment horizon and not to speculate for a speedy recovery leading to a leverage trade to make some quick money. There are signs emerging from the current Russia –Ukraine conflict that it may last for months if not years.

There is never a dull moment in the long-term investing game. Markets are dynamic in nature and are extremely sensitive to the global events and adjust rapidly to almost everything (both positive and negative) that impacts the global economy. As an investor, one must be capable of deciphering the impact of any global event on the economy and on the equity markets, both in the short term and in the long term. Many investors would study the current situation differently as the risk appetite and investment horizon varies from investor to investor.

However, the odds of winning for those investors who are willing to wait it out and add to their investments as market make new lows are much higher than the ones who are willing to take a short-term approach on the market. Wars or no wars, every extreme market condition has been followed by a steady recovery. There is no reason why the current situation will remain a concern forever for the market. The market tends to recovery completely, efficiently and rapidly once it has quantified the maximum damage possible and there is solution in sight for the problem that triggered the market correction.