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Returns Are Never Linear In The Market

Feb 11, 2019 | Dr C K Narayan | Interesting Read, Long Term Impact, Market Related | No Comments

Returns Are Never Linear In The Market

Everywhere you go, you hear of long term investing into equities. Mutual Funds are always pushing their schemes at you, market icons are holding forth all the time and preaching is always about long term. So, it has become a fixity for the market- money is made over the long term.
No dispute. The efflux of time rights many wrongs. The power of compounding kicks in. Fortuitous events happen. We see the indices on an upward path over the years and are convinced with all of these that the adage is indeed true. A look at the long term Nifty chart (see chart 1), shows us that except for some periodic dips the indices have maintained a more or less linear upwardly phased path. Looking at this chart gives us confirmatory evidence that the long term investing is indeed profitable. All one has to do is to buy and sit tight on the investment and wait for it to come thru after some years.

All good so far. Buying something is probably the easiest part. There are enough “sources” around to tell us what to buy. The trouble really is the holding tight part. All of us think that we shall be able to do it. After all, we tell ourselves, we are holding “good” stocks that are “fundamentally strong” and bound to reward over the long term.
What we don’t reckon with is the Volatility in the returns. While statistics like 15% CAGR give us a feeling that the Nifty will give us a smooth 15% return year after year or some other statistic like Nifty moved from 1000 to 10000, a growth of 10x in the past so many years, conveys to us some multibagger visions, no one is quite prepared to handle the way these things actually happen.
For a dose of reality, take a look at chart 2, which shows the Annual returns of the Nifty from the year 1995 till now. What jumps out of the picture is the erratic nature of the return. Just as you were enjoying the gains of 1995, you get hit for negative returns for the next two years. While you were wondering whether to get back in, the market flips around and becomes positive return-oriented for successive years!. So you get back in the game and are enjoying what looks like a good run and before you know it, all the returns and some more was drained away in a single year(2008). You didn’t even get a chance to recover from that hit before the market sped to an astounding 75% return in 2009. This has been followed by a period of low range (relatively) returns that has also been a bit wayward. Three years of good returns (2012-14) was usurped by 2015 drop and the anemic 2016. The dramatic rise in 2017 set the pulses racing only to find 2018 turn into a damp squib!

So, what is one to make of this? The following points should sum it up. It is a list of things that we need to ACCEPT as being REALITIES OF INVESTING.

  1. The chart 2 tells us very clearly that returns are NON LINEAR as well as LUMPY. There may be a few good years but they will be interrupted by weak years as well. Returns DO NOT TREND like prices!
  2. Capital erosion or returns erosion will happen during the down years. This is UNAVOIDABLE.
  3. The above two are the main reasons for asking people to look at long term investing, so that they can allow the resumption in the market cycle upward to kick back in and reward us.
  4. Fund managers can only try to reduce the negative impact of the down years. It is extremely difficult to escape it. This is the reason that one should stick with a mutual fund scheme or a PMS set up for a minimum of 3-4 years.
  5. Cashing out during good years and seeking to enter during lean years is a STRATEGY. Not many can attempt this successfully.
  6. Lean years are time to invest rather than withdraw from PMS or any Advisory service.
  7. Stock moves can vary completely from the overall moves and returns offered by the indices.
  8. Ultimately, your returns are dependent on the stocks that you hold. Usually, stock returns are EVEN MORE VOLATILE compared to Index returns.
    These are important considerations for investing. It is much less romantic and much less exciting than you think. Hindsight bias is high. So is Associative bias. One must try to avoid these. That you could have done something in the past is only a possibility that is already lost. That someone else has fared much better or much worse is only a small yardstick for comparison. Both of these aspects do nothing to change the realities for you.
    At Plus Delta Portfolios, our PMS Service, we try to use an approach that tries to capture a greater amount of return during the up years and seeks to limit the erosion during the down years. We do that using our unique CGM model which we have developed after much research into the markets.
    We must never fight the markets. But for that we need to first accept the nature of the markets. And the fundamental truth of the market is this: While prices can and do trend, returns never do. They are always volatile and nonlinear. We need to accept that else holding on to investments so that they can become winners will never become possible.

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