The case against equity investing: In the long run we are all dead

Vivek Kaul

Stocks are for the long run is a phrase you would have heard often. But that’s not what William H Gross seems to believe anymore. “The cult of equity is dying. Like a once bright green aspen turning to subtle shades of yellow then red in the Colorado fall, investors’ impressions of “stocks for the long run” or any run have mellowed as well,” he wrote in his monthly investment outlook for August 2012.
Gross is the Managing Director of Pacific Investment Management Company (Pimco) and manages Pimco’s Total Return Fund. The Total Return Fund currently has assets under management of $263billion and is the biggest mutual fund in the world.
“An investor can periodically compare the return of stocks for the past 10, 20 and 30 years, and find that long-term Treasury bonds have been the higher returning and obviously “safer” investment than a diversified portfolio of equities,” wrote Gross. So what this clearly tells us is that the higher risk of investing in stocks is not always rewarded with excess return and sometimes it might just make sense to invest in dull and boring bonds which guarantee a given rate of return.
But that’s just one part of the evidence. In the really really long term stocks have done very well. As Gross points out “The long-term history of inflation adjusted returns from stocks shows a persistent but recently fading 6.6% real return (known as the Siegel constant) since 1912.” Hence $1 invested in 1912 would have turned to $500(inflation adjusted) hundred years later i.e. now in 2012. No wonder the Americans took onto investing in stocks like nobody else did. The prime reason for this was the premise that returns from equity beat that from bonds over the long run. Shankar Sharma, joint managing director and vice chairman of First Global explained this phenomenon to me in a recent interview I did for the Daily News and Analysis (DNA) in this way: “Rightly or wrongly, they (the Americans and the much of the Western world) have been given a lifestyle which was not sustainable, as we now know. But for the period it sustained it kind of bred a certain amount of risk taking because life was very secure. The economy was doing well. You had two cars in the garage. You had two cute little kids in the lawn. Good community life. Lot of eating places. You were bred to believe that life is going to be good so hence hey, take some risk with your capital. People were forced to invest in equities under the pretext that equities will beat bonds… They did for a while. Nevertheless, if you go back thirty years to 1982, when the last bull market in stocks started in the United States and look at returns since then, bonds have beaten equities. But who does all this Math?” (You can read the complete interview here)
What has changed now is the ability of Americans to take risk by investing in equity. “Americans are naturally more gullible to hype. But now western investors and individuals are now going to think like us. Last ten years have been bad for them and the next ten years look even worse. Their appetite for risk has further diminished because their picket fences, their houses all got mortgaged. Now they know that it was not an American dream, it was an American nightmare. So I cannot make a case for a broad bull market emerging anytime soon,” said Sharma.
And this seems phenomenon seems to be clearly evident in the numbers that are coming out. As the USA Today reported in mid May: “Stocks remain out of fashion…Retail investors have yanked more than $260 billion out of mutual funds that invest in US stocks since the end of 2008, says the Investment Company Institute, a fund trade group. In contrast, they have funneled more than $800 billion into funds that invest in less-volatile bonds. Investors’ chronic mistrust of stocks is reigniting fears that an entire generation is unlikely to stash large chunks of cash in the increasingly unpredictable market as they did in the past. “Investors have suffered a traumatic shock that has caused severe psychological damage and made them more risk-averse,” says Carmine Grigoli, chief investment strategist at Mizuho Securities USA.”
The phrase to mark here is “risk-averse”. As Sharma puts it “Investing in equity is a mindset. That when I am secure, I have got good visibility of my future, be it employment or business or taxes, when all those things are set, then I say okay, now I can take some risk in life.”
The question that concerns us in India is how will this change in mindset impact India? Before I come to that question let me deviate a little and discuss the concept of naturally occurring ponzi schemes.
A ponzi scheme essentially is a fraudulent investment scheme in which money being brought in by new investors is used to pay off the old investors. The people running the scheme typically promise very high returns to tempt prospective investors to invest money in the scheme. But this money is not invested anywhere to generate returns. The “promise” of high returns ensures that newer investors keep coming in. They money they bring in is used to pay off the older investors. The scheme keeps running till the money being brought in by the new investors is lesser than the money that needs to be paid off to the older ones. This is the point when the scheme collapses. Typically the people who run such schemes disappear with the money, before the scheme collapses.
In his book, Irrational Exuberance, Robert Schiller introduces the concept of Naturally Occurring Ponzi Schemes, which happen without the contrivance of a fraudulent manager. Such a scheme works on a price to price feedback theory. When prices go up creating successes for some investors, this may attract public attention, promote word of mouth enthusiasm and heighten expectations for further price increases. (Adapted from Shiller 2003). The stock market is the best example. Stories about stock markets going up spread very fast. Investors, in an optimistic mood, might want to buy stock and take the stock price further up. This leads to more investors entering the market, fuelling an even greater price rise and the cycle gets repeated over and over. As Shiller mentions, “When prices go up a number of times, investors are rewarded by price movements in these markets, just as they are in Ponzi Schemes.”
The point being that the real returns in the stock market are made when prospective investors are in the Ponzi scheme mode and are willing to invest. A major reason for the bull run in the stock market in India between 2003 and 2007 was the fact that foreign investors brought in a lot of money, thus driving up stock prices and generating returns for those who had already invested. But things have changed over the last five years.
Between April 2007 and July 2012, the foreign investors invested Rs 3,538,108.46 crore in Indian stocks. That clearly is a lot of money. But they also sold Rs 3,537,016.97 crore worth of Indian stocks. This means that the net investment of foreign investors in Indian stocks in the last five years and three months has been a miniscule Rs 1091.49crore.
During the same period the domestic institutional investors made investments worth Rs 1,571,084.73 crore. They sold stocks worth Rs 1,462,118.66 crore. Hence their net investment in stocks was Rs 108,938.27 crore. (Source:
It is this net investment by Indian institutional investors which ensured that the BSE Sensex, India’s premier stock market index, has delivered an absolute return of 30% since April 2007. This means an average return of 5.1% per year. I need not tell you that you would have been better off doing a fixed deposit where the returns were more or less guaranteed. If you had taken on some risk by investing in a mutual fund scheme like Birla Sun Life MIP-II Savings 5 G, you would have managed to get a return of 10.35% per year, more than double that of the stock marekt. The scheme invests 95% of the money collected in debt and the remaining in stocks.
The point I am trying to make is that for the stock market in India to give good returns it is important that foreign investors bring money into India and stay invested in Indian stocks. With their attitudes towards investing in stocks changing whether they will continue to invest in India, remains to be seen.
The other way out is that Indian investors start investing more money in the stock market both directly and indirectly. I don’t see that happening due to two reasons. A lot of Indian investors over the last few years invested money in the Indian stock market indirectly through unit linked insurance plans(Ulips) sold (or rather mis-sold) by insurance companies.
They are now coming to the realization that they have been taken to the cleaners. Money invested five to seven years back is just about breaking even and they would have been much better off by simply letting their money lie idle in a savings bank account.
This is primarily because Ulips used the premium paid by investors to pay very high commissions to insurance agents and did not invest the full premium. So these investors who were taken for a royal ride are not going to come back to the stock market anytime soon.
While systematic investment plans( SIPs) offered by mutual funds have done a lot better than Ulips but the returns are nowhere in the region that would compensate for the increased risk of investing in stocks.
The other reason is a more fundamental reason that was explained to me by Shankar Sharma. “Emerging market investors are more risk averse than the developed world investors. We see too much of risk in our day to day lives and so we want security when it comes to our financial investing… But look across emerging markets, look at Brazil’s history, look at Russia’s history, look at India’s history, look at China’s history, do you think citizens of any of these countries can say I have had a great time for years now? That life has been nice and peaceful? I have a good house with a good job with two kids playing in the lawn with a picket fence? Sorry boss, this has never happened…. Indians have figured out that equities are a fashionable thing meant for the Nariman Points of the world.”
Given these reasons it is difficult to make a case for equities as a long term investment in India as well, though things may not turn to be as bad as they might turn out to be in America and other parts of the Western world.
In the end let me quote an economist who the world always goes back to, when they run out of everything else. As John Maynard Keynes once famously said “In the long run we are all dead”.
(The article originally appeared on on August 6,2012.
(Disclosure: Despite the slightly negative take here, the writer continues to makes regular investments in the Indian stock market through systematic investment plans, though the amount of investments have come down over the last six months)
(Vivek Kaul is a writer and can be reached at [email protected])