During my days in the Indian finance ministry in the early 1990s, we decontrolled the capital market. Our reforms were followed by a stock market boom, which drew in many inexperienced personal investors. The boom collapsed as all booms do, and many investors lost their shirt. This rather late counsel to investors was published in Business World of 21 July 2003.
No sure bets,
only affordable ones
The 1990s broke
the faith of many a saver in the stock market. First there was the great boom
which filled everyone with hope and greed. Thousands of companies were floated
for everything from irrigation to arboriculture. Stockbrokers rode to
television stations in Lexus cars and preached the triumph of capitalism.
Everything promised riches; everyone looked for the ultimate tip. And then the
whole boom collapsed. Companies vanished with investors’ savings. Those that remained
apologized for their bad showing and shunned shareholders. The government
branded Harshad Mehta a scamster and hounded him to his death. Investors
thought that a thousand others were more guilty and had escaped without a
scratch. They showed their disgust by letting company valuations slide.
And then, when
everyone had despaired, stock prices began to rise at the beginning of this
year; by now they are up about a quarter. Analysts say Indian companies have
changed their ways. They have become slimmer and nimbler; they have improved
their margins and their products. They are prepared for global competition. Has
the tiger changed his stripes? Or is he still a shambling giraffe?
These are
profound questions; but it is not necessary for the personal investor to ponder
them. Stock prices have not risen because of corporate virtue; the primary
cause of the rise is the inflow of portfolio investment from abroad. Foreign
investors are no doubt reacting to the corporate story; but they are not
investing. They are allocating their funds; and behind them are investors who
are reallocating money across investments. India was not the only emerging
market to go sour; other markets also lost popularity after the East Asian
meltdown of 1997, and funds flowed out. At that time they had the booming US
market to flow into. In the past three years that market has looked
unattractive. So funds are moving back to emerging markets. They moved first to
East and South-East Asia; there the markets have been rising for over a year.
At some point,
the fund managers were going to ask themselves: how about India? So they did,
and India began attracting money. That is behind our little boom; and its
continuance will depend on the inflow of big funds. They could be the small
investor’s; but if we go by history, it will more likely be foreign funds.
There is no way
to read the foreign fund manager’s mind. Each of them must have some idea of
sustainable value; when those who think that stock prices are unsustainable
command more money than those who think the opposite, the boom will end.
Investment in the stock market involves betting on how the big boys will bet.
Every investor must work out the double bet for herself.
But in the
meanwhile there are some obvious things to do. For one thing, many – perhaps
most – small investors still have their shares in physical scrips. Physical
scrips are so much scrap; today, an investor cannot even get out of the market
unless she dematerializes her shares. It does involve finding the nearest
depository participant and filling up forms. For investors who have been
careless about names, it may involve opening a number of accounts. But this is
the minimum requirement even for an investor who thinks the market has risen
enough and the time has come to exit.
The second thing
is to reduce risk. The money of many small investors is scattered amongst a
large number of nondescript scrips. Ten years ago it was impossible to judge
risk. But today, a simple measure of risk is available, namely the market
turnover in a scrip. This boom is a good opportunity to move out of
little-traded, illiquid scrips and move into the mainstream. And risk can be
reduced further by spreading investment amongst a number of scrips. Liquid
stocks tend to be expensive, and many small investors many not be able to
spread their holdings across a number of them. In that case they should invest
in mutual funds. If they are completely clueless and mistrustful, there are
index funds for them, and soon there will be exchange-traded funds.
Third, investment
in the stock market – just like in lotteries or in horse races – should be
based on capacity to lose, and not by hopes of a win. Money that is won may be
lost tomorrow; but money that is lost is lost forever. And for that lost money
there are many competing uses, from the daughter’s school fees to feeding the
hungry. Loss of money is loss of freedom to do many things that are waiting to
be done. Hence potential losses must be affordable – affordable not out of
earnings that are hoped for, but that wealth already accumulated. Hence the
foremost lesson is: limit your bets.
And finally, every boom must have an end;
and the higher the stock market climbs, the closer that end must be. Every
investor must ask herself all the time: has the market peaked? The economist’s
advice, that shares are a long-term investment, may be all right for those who
do not need money in this lifetime. But we ordinary mortals can use money
today, and should make it while we can.
