The Mutual Fund Show: How Investor Behaviour Impacts Returns
Overreaction is probably the most common effect of human behaviour on stock market.
People are wired to react to situations of fear and greed, said Kalpen Parekh, president of DSP Mutual Fund. “Temperament and objectivity play a big role in investments.”
Invest when everyone is fearful and asset classes are available at reasonably good price, Parekh said at BloombergQuint’s weekly series The Mutual Fund Show. “Margin of safety is a behavioral trait that one should aim for.”
Vinit Sambre, head of equities at DSP Mutual Fund, agreed. “The long-term return generated is directly proportional to the growth in economy and corporate profitability.” In the past 25 years, Sambre said, Indian corporate profitability has grown 11-12 percent which is equivalent to investor return as well.
But the mutual fund industry and investor behaviour have changed in the last 20 years, he said. “Earlier, investors used to panic easily but now they are willing to ride out the storm and even add more money during the bad phase of the market.”
This shift in behavior can be partly attributed to investors’ maturity and partly to lower returns by other asset classes, Parekh explained.
Watch the entire conversation here:
Here are edited excerpts from the interview:
How investment behavior would impact returns?
Parekh: In my experience of many years of interacting with a lot of successful investors, one simple statement which I have heard is to behave. It is corroborated by a lot of data. If markets where to give a return of x percent, data shows that investors at large have earned x minus 6-7 percent and that is for the gap of behavior.
The gap of behavior is mainly because of how we as human beings are wired to react to situations of greed and fear.
So, there are periods of times when markets become very heady and human beings at large who are participants in the market become very greedy and irrational. Those are the times when mistakes are made. Similarly, there are times when markets are in panic mode and we become very fearful and react in the wrong way.
In the business of investing, temperament and objectivity play a very big role.
In investing, when there is fear, it should not be flight but fight. It should be about saying that if everyone is fearful and investment and asset classes are available at reasonably good prices with a margin of safety then let me invest more and vice versa. So, that is the original thesis of how behavior plays a role in being a good or bad investor. Over time, with experience, if we are able to get our temperament right, it would be a very good ingredient to be a successful long-term investor.
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How have you managed to become a successful long-term investor? We look at the history of Sensex returns since 1981—more positive years than negative years. And yet people tend to get ruffled whenever these negative periods come by and get out at the wrong time, isn’t it?
Sambre: As an asset category, mutual funds has been all about long-term investment. We keep guiding investors that over a long period, what they will tend to get as returns is probably how the economy, country, corporate India is growing. If we look at the last 25 years’ history of the markets, corporate earnings have grown 11-12 percent and same has been the returns of equity side. By and large we are strong proponents of managing the mid caps and small caps where it makes a lot of sense to play this cycle in its full form—which is where the long term plays a role.
During my tenure as a fund manager, I invested into equities. I saw that there was a period after investment where we had to wait for long before the stocks started generating returns. But this period was compensated in a big way when the returns started coming in and which is where we saw massive gains happening. The phase where the returns were not happening, we kept questioning ourselves that have we done the right thing, we kept going back to the managements, checking our thesis and analysis. What the experience gives, is the confidence to remain invested into the names.
All these past experiences collectively enable us to remain long-term investors. It is all about how strong fundamentally we have analysed these companies and businesses, what is our level of confidence, which is the key factor that allows us to remain put during the bad phase. For us, a bad phase doesn’t mean that the company is going to end. The company is also consolidating. Good companies are strengthening themselves to capture the upside in good phase. So, we have to wait during that phase and which is what we keep guiding the investors about.
During the last 20 years, investor behaviour and market have changed dramatically. Earlier, during market correction, panic used to set in quite early in the game. Now, investors are more educated. They understand that it’s a long-term business, so they don’t react so quickly.
They are willing to put more money during the bad phase.
Your statistics say that in the last two years, equity mutual fund inflow is greater than the previous 16 years put together. Is this a sign of slightly more mature behavior from the average Indian investor who is not ruffled and is fine with staying put with mutual funds too? Is that what you are seeing in your funds too?
Parekh: I will attribute this to a couple of factors—the evolving maturity of the environment which is the investor himself and the framework around him which is people who have been guiding investors on principles of good investing.
People like us who have been constantly reiterating the principles of long-term investing have played some role. I will yet wait and watch as time progresses and as markets become more volatile. Would this same pattern repeat? Then we know if things have changed—though textbook say that behavior is permanently the same but we have to wait and watch.
What has also impacted flows in the last two years is that other options have not done well. So, wherever else we were investing in the past have delivered poor returns. If you notice, the recency bias is working against them.
So, we are seeing a continuation of that pattern in a way. But what has been the structural shift in the last two years is there has been a phase of two rounds of volatility. We saw markets correcting in 2015 and inflows went up. We saw markets correcting in this year from January to now, inflows have held up, and in some pockets, gone up also. More importantly, money is coming through systematic investment plans. Hopefully, this is a structural trend and not a cyclical trend like it was in 2008, 2009 and 2010.
To start with, investors are saying my starting period is 10 years, so that is one data point which gives me confidence. Recently I read somewhere that x percentage of investors have exited in one year. So, there are pockets of investors. Like everything in life, there are good and bad investors, good and bad fund managers.
Over time, the good investors will evolve and continue to benefit from the weak behavior of those who are not doing the right thing. So, it is a zero-sum game in that sense.
Does it help fund managers and fund’s performance if there is knowledge of how long the money is going to be there for?
Sambre: In my reading, any investor coming into equities at what levels of valuation is he is entering the market. If he is entering the market at a much lower valuation level than the historical averages, then chances of investors getting returns quickly is higher. As the valuation level goes up, which is where the investor fancy too keeps catching up, and the momentum and velocity of money also keeps going up. As you keep investing at higher levels, expectations of returns need to be much longer. So, wait period has to be longer. This is all to do with the valuations.
So, how am I justifying the investment today. It’s by saying that if the stock is trading at 50 multiples, two years down the line, the stock looks like 30 multiples.
So, I am willing to wait for two years. Likewise, is my investor ready to patiently wait with me in that fund for two years? So, the objectives have to match.
And hence his and my expectation needs to marry and which is where the level of frustration or level of investors getting spooked with the falls or the market not going anywhere will come down.
What we need to get the investors on board with our philosophy, and our thought process. And if they are investing at higher multiples, then the wait period has to be longer. Those objectives need to be in sync.
Enough people are talking about how we are at the near-term top, not just for Indian markets but for world markets. Is that a cause for worry? Or during this time, it is important for investors to stay put?
Sambre: While we are looking at a market, it is a very polarised market. There are some sections of stocks which have taken the markets and valuations higher and there are some which have seen a correction, specially in mid caps and small caps. So, in a way, while we are looking at market tops, there is one category—small and mid cap. There are some sectors within the large cap, which have actually taken correction. To me, that is healthy in nature and it is reflective of markets going higher.
Some sections of the market have come down to reasonable level. I won’t call it a very attractive level but a reasonable one. It worries us. If people are coming at higher levels of valuations then they have to wait longer. As an economy, we are in a growing mode. Corporate India is looking very confident after all the reforms, strong government focus and capex happening. Corporate India is in a recovery mode. In the last 8-10 years, we have not grown. We will see growth happening. In a way for markets, this will act as a cushion. What will keep creating volatility is the macros around the world and in the domestic market. But what will act as a cushion is the core of the economy—corporate India. During this phase of volatility, there will be an opportunity by SIPs. If investors don’t want to time the market then they can keep tracking the next one year, which will be volatile to invest and look at the long-term picture.