Tuesday, December 1, 2015


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.