by Mr. Nimesh Shah, ICICI Prudential Asset
Management Co. Ltd
When share markets turn volatile, as they
sometimes do, avoid panicking. Keep calm, and keep stocking up equity assets.
Probability of a Loss..!
Risk is generally seen as the probability of a
loss in any asset class. In finance, however, risk is usually seen as
volatility in an asset class in relation to other asset classes, say, equities
to fixed deposits (FDs).
So, greater the volatility, riskier is the
security that’s the common theme.
By that yardstick, though, equities would be the
riskiest of all asset classes. Yet, study after study shows that equity is one
of the best long-term means of wealth creation.
Take for instance a recent Morgan Stanley report.
It said that equity has delivered the best returns in India over 5 year, 10
year, 15 year and 20 year periods, compared with gold, real estate and fixed
deposits, among others. Over a 20-year period, share investment (equities) returned
12.9 %, gold 8.4 %, FDs 5.5% and property 6.2%.
Why, then, is there such a discrepancy in our
perception of risk in equity as an asset class when it can offer some of the
best returns?
Short-term price movements..!
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| Mr. Nimesh Shah, ICICI Prudential Asset Management Co. Ltd |
The answer lies in understanding volatility. One
of the common arguments of investors who do not want to invest in the share
market and seek alternative assets like real estate is that short-term price
movements can get too rough to handle.
Yes, that’s true. Equities are traded in the stock
market daily, and millions of investors, including foreign and domestic
institutions, not to mention the thousands of day-traders, generate such
movement in stock markets.
The sheer volumes coupled with the amount of fund
flows create the turbulence and vast movement in stocks, sometimes daily.
A huge institutional exit / entry can ruffle a
stock price and any investor, for that matter. That apart, fund flows into and
out of the markets, too, have an impact.
By contrast, do investors in real estate look at
ticker prices regularly? No, because there are none. Real estate prices do not
jump up and down on a real-time basis and so cause no euphoria or anxiety in
the hearts of these investors.
Instead, house prices are determined by prices in
and around a particular area; and not through a market-making institution such
as an exchange, which provides prices on a real-time basis.
Contrast this again with cash in your locker.
That too does not move daily; the cash value of Rs.10,000 in your wallet holds
steady.
So, the volatility of cash in your wallet would
be zero compared with volatility of real estate, which is, in turn, lower than
that of stocks. But then, are these alternative assets good investments in the
long run?
Volatility & Risk..!
Mr. Warren Buffett explained the concept of
volatility and risk in his 2014 annual letter to his shareholders.
“Stock prices will always be far more volatile
than cash-equivalent holdings. Over the long term, however,
currency-denominated instruments are riskier investments - far riskier - than
widely diversified stock portfolios that are bought over time and that are
owned in a manner invoking only token fees and commissions. That lesson has not
customarily been taught in business schools, where volatility is almost universally
used as a proxy for risk. Though this pedagogic assumption makes for easy
teaching, it is dead wrong: Volatility is far from synonymous with risk.”
What we should understand is that volatility in
stocks is not the same as risk. Instead, real risk is the loss of purchasing
power - that the Rs.10,000 in your wallet would be reduced to in the longer
run.
As Buffett says, holding cash is riskier than a
stock portfolio built over time.
That brings us then to the key question of
volatility—and why investors are so nervous about it?
Successful investor..!
Sure, when prices rise, the tendency among many
investors is to book profits, deepening the fall. And the little red marks in
portfolios begin to cause anxiety.
However, to be a successful investor, it’s not so
much about managing your portfolio as it is about managing your emotions.
In other words, do not look at the red marks.
Instead focus on the lower prices of equities and the opportunities presented
to pick up equity assets as if on sale.
Volatility is an inherent characteristic of
equities. But that does not imply risk as most people mistakenly think and as
explained by Mr. Buffett.
In fact, one can reduce the perceived risk in
your portfolio by accumulating stocks at lower prices whenever volatility plays
out in the markets. At lower prices, one adds more units of equity assets in an
equity mutual fund for the same amount of money.
You might see a bit of red in a volatile market
and your investment might lose some value, but you still own the asset, and you
can grab some more of it during these times.
Once the volatile periods are past, which
sometimes could take a while longer, the value of your assets will again begin
to rise. Remember, though, it is volatility that allows you to seize more
equity assets on the go.
An easier way to benefit from volatility is to
invest in mutual funds that are designed with intent to do this for you or
simply invest through systematic investment plans.
About the author..
Mr. Nimesh Shah is managing director and chief
executive officer at ICICI Prudential Asset Management Co. Ltd.
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