Rajeev Agrawal is an instructor at Asian Investing Summit 2017.
I remember a conversation with one of my relatives as I was contemplating getting into investing full time. His reaction was, “So you want to gamble full time!” This reaction sums up the reaction of an average Indian investor towards investing in Equity. There is a deep seated feeling that equity investments cannot be trusted and they provide erratic returns at best. This is also the reason why I am so bullish on Indian equities.
With any investments – be it investing in Equity, Real Estate, Private Equity – what others don’t do provides a good hunting ground for finding bargains assuming that the investor understands that area well. John Templeton famous quote elucidates this perfectly, “People are always asking me where is the outlook good; but that’s the wrong question. The right question is: Where is the outlook most miserable?”
In the rest of this article I talk about key drivers which make Indian Equity an interesting asset class for both domestic and international investors over the long term (multi decades). These are broken down into:
- Changing mind set: Investors are gradually realizing that over long-term equity as an asset class is less volatile and provides better returns. This is encouraging investors to invest in equities through SIP (Systematic Investment Plan). SIP enables them to continue to invest even during stressful periods. During the recent demonetization drive (Nov-Dec 2016), Indian investors inflow into Indian equity was able to offset most of the FIIs outflow.
- Successful Role Models: Over the last few years successful Indian investors have become more main stream. New investors can draw inspiration from these successful investors and visualize similar success for themselves. This evolution has been aided by easy availability of teachings from investment greats which has made equity investing more accessible.
- Social proof: Like most human activity, investing is also a highly social activity. As more and more investors start investing in equity markets in India, there will come a tipping point where the default choice will be to invest in the equity markets. Besides, the pain of missing out on higher returns will pull investors into equity
- Shrinking parallel economy: Indian economy used to have a significant component which was below the radar. This parallel economy is expected to shrink dramatically due to the recent demonetisation drive, focus on digitisation, upper limit on cash transactions and benami act enforcement. This reduction in parallel economy will cause money to move away from Real estate and Gold – which was the traditional store of parallel economy – and into financial assets with Equity getting significant allocation.
- Better regulation and improving corporate governance: SEBI as the primary regulator of capital market in India has continually worked to improve transparency and timeliness of disclosures. Coupled with better regulation, company promoters and managements are also realizing that treating investors fairly will ultimately benefit them through better market capitalization.
- Deeper markets: Indian equity markets are unique because of the outsized impact of FII (Foreign Institutional Investors) investment in the Indian equity markets. As FIIs move from “Risk On” to “Risk Off” Indian equity markets used to exhibit significant volatility. However, as more domestic money comes into the market some of the volatility because of this “hot money” should get reduced making the investors more comfortable in investing into the Indian equity market.
- Higher Returns: Indian equity markets have outperformed alternative options – like Gold, Fixed (Term) Deposit and Real Estate – over 5, 10, 15 and 20 years. India has high savings rate at 30%+. Traditionally, most of this savings has gone into physical assets like Real Estate and Gold. However, as investors become more aware of the significant out-performance of Indian equities and for structural reasons (discussed later), more of these savings from Indian investors will go into Equity in the future.
- Favourable taxation regime: India has a favourable taxation regime for equities with 0% long-term capital gains tax and favourable (15%) short-term capital gains tax. Thus the after-tax returns from equity investments are significantly higher.
- Long runway: Many companies in India are in their early stages of development with small market share and compelling value proposition. Given that market size will continue to grow (demographics), if these companies can continue to increase their market share, these companies can grow at high rates for a very long period.
- Multitude of options: There are more than 5,000 companies listed on Indian equity market with about half trading on a daily basis. Most institutional investors focus on the top 200-300 liquid companies thus providing interesting hunting ground for the rest of us who are comfortable dealing with illiquid securities.
These reasons can help one enjoy outsized returns in Indian Equity for a very long time.
While I have laid out the case for investing in Indian equity market, I want to conclude by listing a few pitfalls that all investors should be cognizant of as they invest in the Indian equity market:
- Choose your business partner carefully: While this advice applies in any geography, it is especially relevant in Indian context given that in India one would have limited legal recourse. Main reason for the limited legal recourse is the slow judicial process in giving out judgment.
- Net-nets don’t work as well because of intention of holders: In India one could very easily find many net-nets where the underlying value of the holdings is many multiple of the market value. However, an investor may never see the value get unlocked because the intention of management is to have control in the holding companies through these holding companies.
- High volatility: Indian market may exhibit higher volatility because of “hot money” discussed earlier. So one should be prepared to take advantage of this volatility rather than be swept up in it.
- Businesses which are impacted by government: An investor has to assess the impact government can have on their businesses. This category will obviously include all businesses where government is a majority owner or a significant minority owner. However, businesses in this category would also include areas like toll roads or mining permits. As public pressure mounts, a government may be more inclined to favour vote bank politics rather than commercial prudence.