Equity markets witnessed a sharp correction during the month – at its worst point a few days ago, the market was down 10%, but recovered towards the end of the month, closing down 6.6% for the month. For the year (April – August 2015), the Nifty is down 6.1%. Our portfolios did better than the market, both for the month and for the year. Given the market volatility, it is important for investors to understand long term returns expectations from markets and the associated role of volatility.
The Sensex, as we know today, dates back to April 1979 with a starting value of 100. Over the past 36 years, it has appreciated at the rate of 16.5% pa reaching 26,280 today. There have been more than 50 changes in the Sensex components over these years. Performance of the Sensex has been very good, beating all asset classes (with the added advantage of daily liquidity and tax efficient returns) despite having had companies like Satyam, JP Associates or Premier Auto as components in the Sensex over these years. Over the same period, we have seen innumerable crises – economic, political or terror related. Despite these events, investors who chose to ignore these events would have made an ‘easy’ 16.5% pa tax free returns over these years – the trick of course was to not get shaken off the horse along the way.
It is the inherent nature of equity markets to be volatile. Over the past 25 years, the Sensex, in any average year, tends to see a volatility of 57% (by which we mean the high – low range, so the 57% number implies a range of 100 to 157 during the financial year). Interestingly, volatility over the past 5 years has been on the lower side, at about 31% compared with the historical average of 57%. Volatility is higher for individual components of the Nifty – typically one observes that more stable businesses also tend to have lower volatility. So, while many investors tend to associate volatility on specific days to their general sense of calm or anxiousness, it may be better to look at things from a slightly longer perspective – in calendar 2015 (8 months so far), the high low range volatility is about 19% which is well within historical norms.
We continue to maintain our focus on the long term in terms of our investment philosophy – our emphasis is on buying high quality companies that have stood the test of time, and are expected to grow earnings near or above the nominal GDP growth rate which is around 14-15% pa. Moreover, we wish to buy these stocks at prices that are reasonable. The volatility in stock prices represents an opportunity as explained by Benjamin Graham, provided one is buying into high quality companies and also one is well aware of the value of what one is buying. The corollary to that of course, is that as stocks get closer to the expensive zone, one would also look to trim or exit positions to reduce risk in the portfolio.
With intrinsic value of stocks, on the aggregate, expected to go up over time at a rate that is well above inflation, it makes sense for an investor to be regularly buying into fundamentally sound companies, growing in line with nominal GDP, as long as prices are sensible. Unlike the peak levels seen in 2007 or 2010, stocks are not expensive at present. There are pockets of expensive valuations in some areas, but the general level of the market offers a reasonable reward to risk ratio. We remain focused on the higher end of the quality spectrum and hope to buy at prices that are reasonable.