State of Indian Stock Markets – October 2018

This is the October 2018 update for the State of Indian Stock Markets and includes historical analysis and Heat Maps of Nifty50 as well as Nifty500‘s key ratios, namely P/E, P/BV ratios and Dividend Yield.

Please remember that these numbers are averages of P/E, P/BV and Dividend Yield in each month. Neither Nifty50 heat maps nor Nifty500 heat maps show the maximum or the minimum values for each month. Also, note that NSE publishes PE ratios based on standalone numbers and not consolidated numbers (Read why this may matter too).

Caution – Never make any investment decision based on just one or two ‘average’ indicators (Why?) At most, treat these heat maps as broad indicators of market sentiments and a reference of market’s historical mood swings.

So here are the Nifty 50 Heat Maps…

Historical P/E Ratios – Nifty 50 (Monthly Average)

Historical Nifty PE 2018 October

P/E Ratio (on the last day of October 2018): 25.00
P/E Ratio (on the last day of September 2018): 26.44

The 12-month trend of P/E has been as follows:

Nifty 12 Month PE Trend October 2018

And here are the average figures of Nifty50’s PE for some recent periods:

Nifty Average PE Trends October 2018

Historical P/BV Ratios – Nifty 50

Historical Nifty Book Value 2018 October

P/BV Ratio (on the last day of October 2018): 3.29
P/BV Ratio (on the last day of September 2018): 3.47

Historical Dividend Yield – Nifty 50

Historical Nifty Dividend Yield 2018 October

Dividend Yield (on the last day of October 2018): 1.27%
Dividend Yield (on the last day of September 2018): 1.23%

Now, to the historical analysis of Nifty500 companies…

As the name suggests, Nifty500 is made up of top 500 companies which represent about 95% of the free float market capitalization of the stocks listed on NSE (March 2017).

Nifty50 on other hand is an index of 50 of the largest and most frequently traded stocks on NSE. These represent about 63% of the free float market capitalization of the NSE listed stocks (March 2017).

So obviously, Nifty500 is comparatively a much broader index than Nifty50.

Historical P/E Ratios – Nifty 500

Historical Nifty 500 PE 2018 October

P/E Ratio (on the last day of October 2018): 28.88
P/E Ratio (on the last day of September 2018): 30.21

Historical P/BV Ratios – Nifty 500

Historical Nifty 500 Book Value 2018 October

P/BV Ratio (on the last day of October 2018): 3.10
P/BV Ratio (on the last day of September 2018): 3.24

Historical Dividend Yield – Nifty 500

Historical Nifty 500 Dividend Yield 2018 October

Dividend Yield (on last day of October 2018): 1.19%
Dividend Yield (on last day of September 2018): 1.15%

You can read the previous update here. The State of Markets section has also been updated with new Nifty heat maps (link).

For a detailed analysis of how much returns you can expect depending on when the investments have been made (at various P/E, P/BV and Dividend Yield levels), please have a look at these 3 posts:

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2018 returns Nifty mid cap small cap

How is 2018 treating your investments?

Last few weeks haven’t been easy.

And unless you are a perfect timer, chances are that your portfolio would be down.

By how much? The cut would be less for those who decided to leave the party early and comparatively bigger for those who either came in late or were being way too adventurous.

In times like these when the equity markets are volatile and surprise you daily, you will come across conflicting views. Optimists will try and influence you to buy more as prices drop. Pessimists will, as usual, ask you to take away what you can and run. But it’s not that easy to take either side. We are common people who are realists and lie between the optimists and the pessimists. We use the money to achieve our financial goals and not just worry about beating or not beating the markets.

Volatility in markets is painful. No doubt.

But Markets aren’t Fixed Deposits and hence, rise and fall all the time. It’s normal.

The year 2017 was a great one for most of us.

The journey was smooth and straight and almost one-way, i.e. Up. It made successful investing look extremely easy.

Just one look at the YTD returns in 2017 for large caps, mid caps and small caps in below graph and you will agree that there was very little chance that someone would have not made money:

2017 returns Nifty mid cap small cap

In fact, if I remember correctly, it was one of the least volatile years in recent memory.

But 2018 came and… things changed.

And we have just completed three quarters of this year.

The story has changed and how…

2018 returns Nifty mid cap small cap

At the time of writing (early Oct-2018), the large-cap index Nifty50 has given up all its returns for the year and is mostly flat. In fact, it is down -2% for the year.

But the real price correction has happened in mid- and small-cap indices. One look at the red and blue line in the graph above and you will realize. These are year-to-date figures. Cuts are bad, if not horrible.

And this is just about the indices. Individual companies have fallen much more. Many big names have come down by more than 40-50% and I am not taking any names here.

The divergence between large and non-large caps is quite large and as of date, there has been a massive outperformance of large-cap indices against the non-large cap space.

A couple of months back, I came across an interesting data point that supports this conclusion. Sourced from Stalwart website (link), here is an eye-popping data about the 1584 stocks listed on BSE with a market cap >= INR 100 crore (as on 25th June 2018):

  • Fall of 60% or more from 52-week highs – 106 stocks
  • Fall of 50 to 59% from 52w highs – 175 stocks
  • Fall of 40 to 49% from 52w highs – 289 stocks
  • Fall of 30 to 39% from 52w highs – 359 stocks
  • Fall of 20 to 29% from 52w highs – 336 stocks

The dataset is slightly old (June-end) but I am sure the numbers have deteriorated further. Clearly, the large-cap indices of Nifty50 and Sensex are not reflecting the reality of on-going deep correction in the broader markets.

Even if you were to analyze Mutual Fund Portfolios, the divergence between the returns delivered in the last few months by large-cap funds and non-large cap funds would be clearly evident.

Sadly, the investors who believed that the stellar performance of Mid & Small caps during last year will be repeated this year have been disappointed.

Trees don’t grow to the sky. And neither does the market.

If investors continue to disregard the risk in order to enhance returns, sooner or later they will be caught off guard. In a way, this is exactly what is happening right now.

Mean reversion is a law of markets and cannot be avoided. It happens every now and then. And past experience tells that it can be ferocious in the short term. Many who were small-cap heavy in last 2-3 months would agree with that now.

If you already know me, you will agree that high valuations make me uncomfortable. 🙂 I am not a Growth-At-Any-Price kind of investor. Rather, I am a valuation conscious common man who gives cognizance to the real risks.

Since last year or so, there was absolutely no doubt that valuations were stretched (check this and this). And if mean reversion does work (and I believe it does), then sooner or later this kind of correction was expected.

I know we cannot perfectly time the markets. But valuations do act as a guide. And we need to respect it.

Please don’t think that I am trying to portray myself as someone who got the timing of this correction right. Using the State of Markets Tracker, I have been highlighting the risk of the on-going increase in valuations for some time now. So to be fair, this road bump in returns was bound to come sooner or later.

Nevertheless… what next?

I don’t know.

Even after the recent fall in small/mid-cap space, the valuations are still not cheap. Large caps still seem to be overvalued from a historical perspective. But not as overvalued as they were maybe at the start of the year. But having said that, it must also be acknowledged that there are several moving parts right now – like the mood of the population as elections approach, crude oil, geopolitical stuff, sector-specific issues, valuation itself, etc. I am not trying to paint a bleak picture here and I don’t think that this is the repeat of 2008 crisis. But the reality is that no one knows how the current situation will further evolve. And if the panic does take over due to any reason whatsoever, then the stress will increase across the board.

Although as long-term investors, we should not react to the short-term movements in the market, we nevertheless need to remain awake and have adequate situational awareness and link it to historical trends.

If you believe in goal-based investing and are investing for your long-term goals, then you should remain focused. You are already investing in line with your suggested asset allocation and hence, you should stick to it. If you are a SIP investor in mutual funds and your goals are still several years away, you should continue your regular investments as the strategy is good enough and works only if you continue to invest in falling markets too. Unfortunately, if your financial goal is more immediate and you were still heavily in equity, then you had it coming. Your allocation was wrong to begin with as for short-term goals, large % of equity should be avoided for most investors.

If you already hold a large-ish portfolio, then you should respect your strategic asset allocation (assuming you were wise enough to have thought about it earlier) and act accordingly. Ideally, rebalancing should have begun much earlier. Now it’s the market that is rebalancing the portfolios by force.

If you have surplus money to invest, don’t be too excited and try to do anything adventurous. You are excited and we all know that. Let the dust settle a bit more. Being in cash is also a decision. And cash has immense power in such markets.

Every now and then when high valuations and other factors line up in some combination, the markets will have their corrections. In theory, everyone knows how they should react to market falls. But in reality, we can’t be very sure of our actions as our real tolerance for market falls may not be what we think it is.

But corrections are normal and healthy and we should pray for them.

In fact, panic weeks and months are common if you increase the time scale under consideration. And once you do that, the earlier corrections or even the ongoing correction will seem like a blip in the returns that disciplined long-term investors eventually reap. So do not be afraid of this one. Even this will pass away.

It would still not be a bad idea to remain cautious for some more time. It is easy to be carried away by the panic selling. There is a time to be bold and there is also a time to not be bold. Depending on who you are and what goals you are saving for, you need to decide what you will be doing.

 

State of Indian Stock Markets – September 2018

This is the September 2018 update for the State of Indian Stock Markets and includes historical analysis and Heat Maps of Nifty50 as well as Nifty500‘s key ratios, namely P/E, P/BV ratios and Dividend Yield.

Please remember that these numbers are averages of P/E, P/BV and Dividend Yield in each month. Neither Nifty50 heat maps nor Nifty500 heat maps show the maximum or the minimum values for each month. Also, note that NSE publishes PE ratios based on standalone numbers and not consolidated numbers (Read why this may matter too).

Caution – Never make any investment decision based on just one or two ‘average’ indicators (Why?) At most, treat these heat maps as broad indicators of market sentiments and a reference of market’s historical mood swings.

So here are the Nifty 50 Heat Maps…

Historical P/E Ratios – Nifty 50 (Monthly Average)

Historical Nifty PE 2018 September

P/E Ratio (on last day of September 2018): 26.44
P/E Ratio (on last day of August 2018): 28.40

The 12-month trend of P/E has been as follows:

 

Nifty 12 Month PE Trend September 2018

And here are the average figures of Nifty50’s PE for some recent periods:

Nifty Average PE Trends September 2018

Historical P/BV Ratios – Nifty 50

Historical Nifty Book Value 2018 September

P/BV Ratio (on last day of September 2018): 3.47
P/BV Ratio (on last day of August 2018): 3.76

Historical Dividend Yield – Nifty 50

Historical Nifty Dividend Yield 2018 September

Dividend Yield (on last day of September 2018): 1.23%
Dividend Yield (on last day of August 2018): 1.15%

Now, to the historical analysis of Nifty500 companies…

As the name suggests, Nifty500 is made up of top 500 companies which represent about 95% of the free float market capitalization of the stocks listed on NSE (March 2017).

Nifty50 on other hand is an index of 50 of the largest and most frequently traded stocks on NSE. These represent about 63% of the free float market capitalization of the NSE listed stocks (March 2017).

So obviously, Nifty500 is comparatively a much broader index than Nifty50.

Historical P/E Ratios – Nifty 500

Historical Nifty 500 PE 2018 September

P/E Ratio (on last day of September 2018): 30.2
P/E Ratio (on last day of August 2018): 34.5

Historical P/BV Ratios – Nifty 500

Historical Nifty 500 Book Value 2018 September

P/BV Ratio (on last day of September 2018): 3.24
P/BV Ratio (on last day of August 2018): 3.52

Historical Dividend Yield – Nifty 500

Historical Nifty 500 Dividend Yield 2018 September

Dividend Yield (on last day of September 2018): 1.15%
Dividend Yield (on last day of August 2018): 1.04%

You can read the previous update here. The State of Markets section has also been updated with new Nifty heat maps (link).

For a detailed analysis of how much returns you can expect depending on when the investments have been made (at various P/E, P/BV and Dividend Yield levels), please have a look at these 3 posts:

State of Indian Stock Markets – August 2018

This is the August 2018 update for the State of Indian Stock Markets and includes historical analysis and Heat Maps of Nifty50 as well as Nifty500‘s key ratios, namely P/E, P/BV ratios and Dividend Yield.

Please remember that these numbers are averages of P/E, P/BV and Dividend Yield in each month. Neither Nifty50 heat maps nor Nifty500 heat maps show the maximum or the minimum values for each month. Also, note that NSE publishes PE ratios based on standalone numbers and not consolidated numbers (Read why this may matter too).

Caution – Never make any investment decision based on just one or two ‘average’ indicators (Why?) At most, treat these heat maps as broad indicators of market sentiments and a reference of market’s historical mood swings.

So here are the Nifty 50 Heat Maps…

Historical P/E Ratios – Nifty 50 (Monthly Average)

Historical Nifty PE 2018 August

P/E Ratio (on last day of August 2018): 28.40
P/E Ratio (on last day of July 2018): 28.22

The 12-month trend of P/E has been as follows:

Nifty Average PE Trends August 2018

 

And here are the average figures of Nifty50’s PE for some recent periods:

Nifty 12 Month PE Trend August 2018

Historical P/BV Ratios – Nifty 50

Historical Nifty Book Value 2018 August

P/BV Ratio (on last day of August 2018): 3.76
P/BV Ratio (on last day of July 2018): 3.70

Historical Dividend Yield – Nifty 50

Historical Nifty Dividend Yield 2018 August

Dividend Yield (on last day of August 2018): 1.15%
Dividend Yield (on last day of July 2018): 1.18%

Now, to the historical analysis of Nifty500 companies…

As the name suggests, Nifty500 is made up of top 500 companies which represent about 95% of the free float market capitalization of the stocks listed on NSE (March 2017).

Nifty50 on other hand is an index of 50 of the largest and most frequently traded stocks on NSE. These represent about 63% of the free float market capitalization of the NSE listed stocks (March 2017).

So obviously, Nifty500 is comparatively a much broader index than Nifty50.

Historical P/E Ratios – Nifty 500

Historical Nifty 500 PE 2018 August

P/E Ratio (on last day of August 2018): 34.50
P/E Ratio (on last day of July 2018): 33.59

Historical P/BV Ratios – Nifty 500

Historical Nifty 500 Book Value 2018 August

P/BV Ratio (on last day of August 2018): 3.52
P/BV Ratio (on last day of July 2018): 3.45

Historical Dividend Yield – Nifty 500

Historical Nifty 500 Dividend Yield 2018 August

Dividend Yield (on last day of August 2018): 1.04%
Dividend Yield (on last day of July 2018): 1.08%

You can read the previous update here. The State of Markets section has also been updated with new Nifty heat maps (link).

For a detailed analysis of how much returns you can expect depending on when the investments have been made (at various P/E, P/BV and Dividend Yield levels), please have a look at these 3 posts:

Getting Rich without Going Into Unsafe Territories

Getting Rich without Going Into Unsafe Territories

Let’s get straight to the point.

You want to become rich and you want to become rich FAST!

That’s what we all want right?

Thankfully, most of us understand that it’s easier said than done. But unfortunately, far too many don’t get it and end up losing tons of money instead of making it.

And the internet does what it does best – adds to the noise – and is overcrowded with a lot of misleading information on how to become wealthy. To be fair, it’s quite possible to get rich quickly, more often than you’d think.

However, it comes with a high probability of losing whatever you put into such get-rich-quick ventures. And it involves taking high-risks, putting in hard work and ofcourse a lot of luck – or let’s say a ‘lucky’ combination of all the three.

Stock market investors who get greedy after noticing a good run in certain stocks for a couple of years start believing the stock market is a sneaky way to get rich very fast.

Sometimes this is true for the short run. But mostly it’s not. After a good run, mean reversions reframe the game and markets go down. And people aren’t ready for it.

As a result, people end up losing whole life investments or at best end up with a very bad experience with equities – and that can haunt them for years, make them stay away from equities (and it just translates into a big loss of wealth creation opportunities).

Another example can be the almost vertical rise in value of cryptocurrencies like Bitcoin in the very recent past.

Again what happened there was that people believed that this is a way to get rich overnight and so hoards of investors started joining the party. But the crash that happened after the all-time highs has left most people with a bad taste for currency investments. To be honest, cryptocurrency isn’t my field of expertise, but I have close friends in Silicon Valley who have actually got rich taking a cut of this modern-day currency market.

And I mean they became filthy rich way too fast. Some were lucky to cash out before the big fall and have literally achieved financial independence. Others weren’t so lucky. I would say that in the case of crypto-riches, luck played a really big part for many people’s good fortune – there can be no denying that.

Also, there is the foreign exchange or currency market also known as forex – which I’m not sure most people know is the biggest market in the world!

If you surf around enough online financial and trading sites, chances are that soon enough, our Lord Google will contextually throw in alluring Forex Trading advertisements which highlight the magical capabilities of currency trading offers.

I personally know someone abroad who does quite well dealing in forex trading. And he has been doing it for years so he knows his trade. If you were to ask him whether it’s possible to get rich in forex trading he’d say ‘Hell yes!’. But if you were to ask him whether it’s easy to get rich trading in the forex market, he would say right off the bat ‘No way!’.

In fact, he very clearly told me that Forex Trading is not a get-rich-quick method as many online advertisements make it out to be. That doesn’t happen. It’s a skill and takes time to learn and profit from. Being properly equipped with certain tools to trade in forex and having timely funds along with proper non-impulsive risk management skills are valuable assets when going the forex way.

I, being a participant in Indian stock markets for several years, could clearly see the similarities with it.

The insights about what works and what doesn’t work in stock markets come after years of trying out various strategies, taking hits on your portfolio and your ego and what not.

It might seem that it’s easy but I can vouch that there is no easy money-making here. It is simple but not easy.

Another close acquaintance of mine got really lucky sometime back. He piggybacked another friend’s VC and Angel around bets without any clue about what the startups were exactly doing. Lady luck shined and he made a killing with a couple of super bets.

You see the pattern?

Some people ‘get rich quick’ here and there. But they are the exception to the rule, not the norm.

You need to realize that for most people, the way to wealth is typically on the slow lane. It’s good to take your chance, but more often than not, what happens is that your capital gets lost and you need to start fresh. Which is hard stuff. After a while it adds up, less money is available for compounding and naturally, the amount of money you end up making is much lesser than what would have been possible if you’d have not run greedily towards a quick highly risky scheme.

Believe me, you can wait for years to accept the perennial truth that slow and steady wins the race and compounding is indeed the 8th wonder of the world. Or you can start with time-tested wealth creation strategies and begin your journey of being really wealthy.

It might not seem as glamorous as the get-rich-quick schemes but it works.

By starting early, you can be rich enough much before you retire – something that is desirable as you don’t want to be the richest man in the graveyard! Right?

Frequently, getting rich quickly is either due to pure coincidence or extreme risk. But even hard work and willingness to take tons of risks cannot guarantee overnight riches.

So do yourself and your family a favor and assume calculated risk, invest in testing out the best strategies and work only with the best ones. Don’t ever take luck or hope into account! Both hope and luck are not strategies. 🙂

May the odds be in your favor!

State of Indian Stock Markets – June 2018

This is the June 2018 update for the State of Indian Stock Markets and includes historical analysis and Heat Maps of Nifty50 as well as Nifty500‘s key ratios, namely P/E, P/BV ratios and Dividend Yield.

Please remember that these numbers are averages of P/E, P/BV and Dividend Yield in each month. Neither Nifty50 heat maps nor Nifty500 heat maps show the maximum or the minimum values for each month. Also, note that NSE publishes PE ratios based on standalone numbers and not consolidated numbers (Read why this may matter too).

Caution – Never make any investment decision based on just one or two ‘average’ indicators (Why?) At most, treat these heat maps as broad indicators of market sentiments and a reference of market’s historical mood swings.

So here are the Nifty 50 Heat Maps…

Historical P/E Ratios – Nifty 50 (Monthly Average)

Historical Nifty PE 2018 June

P/E Ratio (on last day of June 2018): 25.90
P/E Ratio (on last day of May 2018): 27.19

The 12-month trend of P/E has been as follows:

Nifty 12 Month PE Trend June 2018

And here are the average figures of Nifty50’s PE for some recent periods:

Nifty Average PE Trends June 2018

Historical P/BV Ratios – Nifty 50 (Monthly Average)

Historical Nifty Book Value 2018 June

P/BV Ratio (on last day of June 2018): 3.61
P/BV Ratio (on last day of May 2018): 3.69

Historical Dividend Yield – Nifty 50 (Monthly Average)

Historical Nifty Dividend Yield 2018 June

Dividend Yield (on last day of June 2018): 1.22%
Dividend Yield (on last day of May 2018): 1.23%

Now, to the historical analysis of Nifty500 companies…

As the name suggests, Nifty500 is made up of top 500 companies which represent about 95% of the free float market capitalization of the stocks listed on NSE (March 2017).

Nifty50 on other hand is an index of 50 of the largest and most frequently traded stocks on NSE. These represent about 63% of the free float market capitalization of the NSE listed stocks (March 2017).

So obviously, Nifty500 is comparatively a much broader index than Nifty50.

Historical P/E Ratios – Nifty 500 (Monthly Average)

Historical Nifty 500 PE 2018 June

P/E Ratio (on last day of June 2018): 30.47
P/E Ratio (on last day of May 2018): 31.59

Historical P/BV Ratios – Nifty 500 (Monthly Average)

Historical Nifty 500 Book Value 2018 June

P/BV Ratio (on last day of June 2018): 3.37
P/BV Ratio (on last day of May 2018): 3.49

Historical Dividend Yield – Nifty 500 (Monthly Average)

Historical Nifty 500 Dividend Yield 2018 June

Dividend Yield (on last day of June 2018): 1.09%
Dividend Yield (on last day of May 2018): 1.08%

You can read the previous update here. The State of Markets section has also been updated with new Nifty heat maps (link).

For a detailed analysis of how much returns you can expect depending on when the investments have been made (at various P/E, P/BV and Dividend Yield levels), please have a look at these 3 posts:

State of Indian Stock Markets – April 2018

This is the April 2018 update for the State of Indian Stock Markets and includes historical analysis and Heat Maps of Nifty50 as well as Nifty500‘s key ratios, namely P/E, P/BV ratios and Dividend Yield.

Please remember that these numbers are averages of P/E, P/BV and Dividend Yield in each month. Neither Nifty50 heat maps nor Nifty500 heat maps show the maximum or the minimum values for each month. Also, note that NSE publishes PE ratios based on standalone numbers and not consolidated numbers (Read why this may matter too).

Caution – Never make any investment decision based on just one or two ‘average’ indicators (Why?) At most, treat these heat maps as broad indicators of market sentiments and a reference of market’s historical mood swings.

So here are the Nifty 50 Heat Maps…

Historical P/E Ratios – Nifty 50 (Monthly Average)

Historical Nifty PE 2018 April

P/E Ratio (on last day of April 2018): 26.66
P/E Ratio (on last day of March 2018): 24.66

The 12-month trend of P/E has been as follows:

Nifty 12 Month PE Trend April 2018

And here are the average figures of Nifty50’s PE for some recent periods:

Nifty Average PE Trends April 2018

Historical P/BV Ratios – Nifty 50 (Monthly Average)

Historical Nifty Book Value 2018 April

P/BV Ratio (on last day of April 2018): 3.69
P/BV Ratio (on last day of March 2018): 3.42

Historical Dividend Yield – Nifty 50 (Monthly Average)

Historical Nifty Dividend Yield 2018 April

Dividend Yield (on last day of April 2018): 1.19%
Dividend Yield (on last day of March 2018): 1.29%

Now, to the historical analysis of Nifty500 companies…

As the name suggests, Nifty500 is made up of top 500 companies which represent about 95% of the free float market capitalization of the stocks listed on NSE (March 2017).

Nifty50 on other hand is an index of 50 of the largest and most frequently traded stocks on NSE. These represent about 63% of the free float market capitalization of the NSE listed stocks (March 2017).

So obviously, Nifty500 is comparatively a much broader index than Nifty50.

Historical P/E Ratios – Nifty 500 (Monthly Average)

Historical Nifty 500 PE 2018 April

P/E Ratio (on last day of April 2018): 31.36
P/E Ratio (on last day of March 2018): 29.65

Historical P/BV Ratios – Nifty 500 (Monthly Average)

Historical Nifty 500 Book Value 2018 April

P/BV Ratio (on last day of April 2018): 3.56
P/BV Ratio (on last day of March 2018): 3.27

Historical Dividend Yield – Nifty 500 (Monthly Average)

Historical Nifty 500 Dividend Yield 2018 April

Dividend Yield (on last day of April 2018): 1.04%
Dividend Yield (on last day of March 2018): 1.12%

You can read the previous month’s update here. The State of Markets section has also been updated with new Nifty heat maps (link).

For a detailed analysis of how much returns you can expect depending on when the investments have been made (at various P/E, P/BV and Dividend Yield levels), please have a look at these 3 posts:

3 Big Changes that will impact Mutual Fund Investors

Big Changes in Mutual Fund

Last few months have been very dynamic and interesting for the mutual fund industry.

3 big changes have taken place that are going to impact all mutual fund investors and how they take their investment decisions in future.

If you are a little confused about what these changes are, then let me calm you down.

Maybe you have already heard about them but not understood their impact fully. Or it might have slipped off your mind as the impact may not be immediate or even short term. Nevertheless, I feel that these 3 changes need to be understood by you as long-term mutual fund investors.

So without wasting more time or making it a very long post, I will try to highlight what these changes are.

By the way, I have already written about two of these changes in super detail earlier. I will share the links two those articles shortly.

So what are these changes?

  1. Introduction of Long-Term Capital Gains Tax (LTCG) on equity
  2. Categorization & Rationalization of existing funds
  3. Use of TRI or Total Return Index for benchmarking of funds

If all three seem boring and too technical to you, then please hold on (and don’t close the window).

These are important changes. These are not just administrative changes that will have no impact on you. These three (yes…all three of them) will impact you and have a role to play in how much wealth you will create. So it makes sense to understand these changes.

Please. 🙂

Your money. Your responsibility.

I hope you are still reading.

Let’s get into these changes now…

1) Introduction of Long-Term Capital Gains Tax (LTCG) on equity

Unlike earlier years, your profits (capital gains) from equity after 1 year will now be taxed. So the actual money that you get in hand will be little lesser than what you would have got in a zero-LTCG regime.

But I won’t get into the details about LTCG tax here.

I have already addressed the impact of LTCG tax on long term investors in a super detailed post mentioned below:

Real impact of LTCG tax on long term equity investors

So I strongly recommend you read that post if you haven’t already.

It’s a little long but that should not stop you from reading it as its important. Bookmark it and read it when you have made time for it.

2) Categorization & Rationalization of existing funds

The regulator SEBI has ‘forced’ the fund houses to clean up their acts and make their fund offerings more logical, simpler to understand and more investor-friendly. This also forces the fund houses to be truthful to what they are offering.

This might seem just like a cosmetic change upfront to many. But it isn’t. This is one of the biggest change in Mutual fund space in recent years.

This will directly impact your investments as some of the funds will see big changes in their portfolio. And if you are MF star-rating lover, then please note that this will also impact how much returns some of the earlier 5-star rated and popular but now ‘rationalized’ funds will deliver.

So if you are an existing investor of any of these funds, then you will be impacted. So logically speaking, you should sit up and take notice of this change.

Want more details to understand it?

I have written a huge article on this.

Here is the link to that article:

Real impact of the NEW Categorization & Rationalization of existing mutual funds that YOU have Invested in

Please read it. Like the first one, this too is important even if you don’t feel it is right now.

That brings us to the last one…

3) Use of TRI (Total Return Index) for benchmarking of funds

(I haven’t written about this topic. So I will tackle it here itself in some detail)

This is another important development. It won’t put more money in your pocket directly. But it can help you take better decisions when picking right mutual funds – which in turn can put more money in your pocket eventually. 🙂

I will explain myself in a bit.

The respected regulator SEBI has asked all mutual fund houses to adopt the Total Return Index (TRI) to benchmark their schemes.

According to the regulator (and many others), this is a more appropriate way to measure the performance of such financial products. Here is a link to SEBI’s circular on TRI adoption for benchmarking fund mutual performance – Link

Till now, most equity mutual fund schemes have been benchmarked to the Price Return variant of the Index (PRI).

So what is the difference between this new animal TRI and the old PRI?

When you invest, there are 2 components of the total return you can make from your investments. First is ofcourse capital appreciation, And the second is the dividends from that investment.

If you only consider capital appreciation, then it means you are looking at PRI version. But if dividends are factored in too alongwith the capital appreciation, then that’s TRI – Total Returns.

Naturally, the returns of a total return index will always be higher than that of a price index.

Let’s now come back to the mutual funds.

The MFs receive dividends on the stocks they hold in their portfolios and this dividend is re-invested into the scheme. So ideally, they should compare their performance with Total Returns Index. That would be fair. But as I said earlier, they use PRI or Price-only Index.

How does it change the depiction of fund manager’s ability?

Suppose a Rs 100 invested in a fund becomes Rs 120.

The PRI index (which is generally used) to benchmark has grown itself from 100 to 112 in meantime. So in this case, the outperformance over and above the benchmark is Rs 8 = (Rs 120 – Rs 112).

On the other hand, TRI includes dividends and hence will be higher than PRI. Suppose it is 116. Obviously, the outperformance over and above the benchmark is now reduced to just Rs 4 = (Rs 120 – Rs 116).

Here is a simplistic summary:

Total Return benchmark Indian mutual funds

What has happened and why have fund managers been using PRI till now?

As returns appear lower in case of a PRI, it is easier for a fund to show higher out-performance against it. Read the previous statement again.

So when the fund compares itself with a PRI, it shows a much higher outperformance than it is actually doing (when compared with TRI). 🙂 🙂

PRI doesn’t capture the dividends which are available for the fund. TRI does that.

This gap between the price-only returns and Total-Returns in a way tells that by avoiding the recognition of dividends (in TRI), it actually helps the case of fund managers as they can set a lower bar on the returns that they need to make to ‘outperform’ the benchmark! 🙂

This might seem bad but luckily, SEBI has taken care of this by forcing fund houses to adopt TRI now. I am sure that if SEBI had not pushed the fund houses, most MFs would have continued to use PRI benchmarks. To be fair, few fund houses had already adopted the TRI for benchmarking even before the regulations came. Cheers to them!

I did some number crunching with Nifty50 data of last 10 years (Apr-2008 to Mar-2018).

The Nifty returned 7.87% over this 10-year period, while it’s TRI version returned 9.16% over the same duration.

Now suppose the fund you invested in gave a return of 10% in the same period. If you use PRI, then outperformance is 2.13% whereas if you use TRI, the outperformance over benchmark reduces to just 0.84%.

Nifty Total Return benchmark mutual funds

It is still outperforming the benchmark, but as you might have noticed, the outperformance (or what fund managers take credit for and become celebrities) can go down significantly due to change in benchmarks.

Hence, TRI is more appropriate as a benchmark to compare the performance of mutual fund schemes. And going forward, atleast some of the funds will have a tougher time beating this benchmark – something that they were able to do easily earlier. This pushes fund managers to work harder to generate real alpha (outperformance) and not rely on technical differences between TRI and PRI to artificially bloat their alphas.

But nothing is perfect.

Some people are saying that even the TRI is not perfect.

Why?

Because mutual funds have to keep some liquid cash aside too – for liquidity needs and in search of better opportunities. And the index – which is the benchmark does not have to keep this cash! So if this cash component of the fund is slightly large, then it can drag down the overall performance of the fund. And this reality is not captured by the TRI.

So it seems that the PRI was overstating performance while the TRI is ‘slightly’ understating it when compared to the index. 🙂

This is true to an extent. But I don’t buy the argument completely as cash was held even under the PRI regime. This is nothing new that is introduced in the TRI regime. Isn’t it?

As I said, nothing is perfect. So we really cannot ignore the investor-friendliness of using TRI over PRI for benchmarking.

But it is important to highlight something here:

The use of Total Returns version of the Index for benchmarking has absolutely no impact on the actual returns generated by the mutual funds. It is just done to ensure that fund performance is compared more accurately against a correctly chosen benchmark.

I know what you are thinking.

If this doesn’t impact the actual returns, why should we even be bothered?

There is a need to understand this difference between total return and price return. And it is because when you are picking good mutual funds to invest in, one of the many important criteria is to see how is the fund’s consistency with respect to its benchmark. As since beating the benchmark will be slightly tougher now, this factor will play its role in the proper selection of good mutual funds to invest in for the long term.

Let me remind that beating benchmarks is not the only factor in fund selection. There are several others which are important enough.

Another thing to note here is that changeover to TRI in no way means that fund managers will not beat their benchmarks. It only means that the number of funds beating the same benchmarks will be reduced in years to come. This fact will get a further push as SEBI’s directive to rationalize mutual funds has asked fund houses to just have one fund per category.

On a related note, some people are of the view that since beating benchmarks will be tougher, its best to go for index funds. There is no clear-cut answer here, to be honest.

Index fund is a beautiful product. More so now. But still, good fund managers will continue to do better than those index funds.

But the margin of their outperformance will get reduced to some extent. And as the years progress, the difference (or outperformance) will get reduced on a category basis. I will still not write off active equity funds as I believe that proper fund selection can increase the probability of finding index-beating and proper-benchmark beating funds.

But I agree, that the time for index funds will come soon.

And now more than ever, it’s true that an Index fund may not beat a good fund manager. But it will surely beat a bad one. 🙂

Why is SEBI pushing for so many changes in the Mutual Fund industry?

Many followers of the MF industry (me included) can vouch for the fact that the last few months have been quite eventful for the industry as a whole.

Implementation of LTCG on equity gains by the government, rationalization of schemes and forcing adoption of TRI by SEBI – these are not small developments.

And as far as I can make out, the future will see more announcements of such regulatory measures.

As you might have guessed by now, these are being done to ensure that the industry remains investor-friendly and curb misselling to some extent.

The industry is growing by leaps and bounds and as more and more people are joining the mutual fund bandwagon believing that #MutualFundSahiHai, it is only rightful that the regulator is doing its bit to nudge the industry to clean up and take a moral high ground.

I hope this article that focuses on use of Total Returns Index for benchmarking by mutual funds and other two focusing on tax on LTCG from equity and Categorization & Rationalization of Mutual Funds were able to give you the clarity that you need to have regarding these changes.

For common people, the Mutual funds are the best investment option to create wealth in the long run. And with new changes, it is expected that industry will be better regulated and investors will have the right information to ask the right questions from their fund managers.

Inspite of these 3 changes, nothing changes in how you should go about managing your money. Know yourself and your financial goals. Get yourself a good financial plan that gives you a roadmap to invest properly. And then, stick to the plan and continue monitoring your investments properly. That’s all that is needed.

So happy investing.

If you have any questions pertaining to these developments or want to take professional help in creating a solid financial plan (details here), please contact me.