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Aarati Krishnan

INVEST in the stock market, stay on patiently through its ups and downs, and you will be rewarded with higher returns than from any other asset class. This is the advice often handed out to investors who complain of diminishing returns from their fixed-income investments.

But an analysis of stock market returns for a 10-year holding period suggests that this maxim is not infallible in the Indian context. For investors who were willing to regularly invest in the stock market, there was a six in ten chance of making a reasonable return of 20 per cent per annum, if they held their investments over a ten-year period.

But on quite a few occasions over the past two decades, the Indian stock market has seen bursts of intense activity driven by speculative excesses. For investors who have been unfortunate enough to enter the market during one of these phases, returns on investment may have been negative, even after a ten-year wait.

Rolling returns for a better picture

An investment of Rs10,000 in the BSE Sensitive Index (Sensex) made precisely ten years back, would now be worth Rs 16,193, having appreciated at a compounded rate of just 5 per cent per annum.

This may seem like an open-and-shut case against equity investing. But a simple computation of point-to-point returns between June 30, 1993 and June 30, 2003, does not offer a realistic view of actual returns to investors. For instance, the ten-year return to an investor who entered the stock market in January 1991 and sold out in January 2001, would have been 16 per cent!

To get a realistic picture of how investors who entered and exited the market at different points in time between January 1990 and June 2003 would have fared, rolling returns at each month-end were computed to gauge the ten-year returns.

(A rolling return for January 1990 would compare Sensex values by end-January 1990 to Sensex values at the end of January 1980. A rolling return for February 1990 would compare values that month with those for February 1980, and so on. The exercise was repeated for the 162 months between January 1990 and June 2003).

This exercise shows that the average compound returns an investor would have made over any ten-year holding period between 1990 and 2003, was 20 per cent per annum. But this "average" evens out some uninspiring numbers.

In reality, investors would have made a reasonable return over a ten-year holding period on six out of 10 occasions in the past 13 years.

If a return of 20 per cent per annum is taken as a reasonable expectation from the stock market, you would have managed this return in 92 of the 162 rolling ten-year periods between 1990 and 2003. In 70 out of 162 periods, the stock market provided poor or even negative returns for a ten-year holding period.

Ten-year hold: Not loss-proof

Stock markets go through wild swings from year to year. While large positive returns are a possibility, so is a substantial erosion in the value of your investment. From 1990 to 2003, yearly returns on the Sensex swung between a high of 67 per cent (in 1999) and a low of minus 21 per cent (in 2000).

Does holding your investments for a ten-year period protect you from erosion in the value of your equity investment? Not entirely.

On three occasions between January 1990 and June 2003, an investor would have actually faced erosion in the value of his investment after remaining invested in the stock market for a full ten years. Investments made in March 1992, April 1992 and September 1992 turned in negative holding-period returns ten years later, in 2002.

"Real" possibility of negative returns

Given that inflation can wreak considerable damage on your investments over a long holding period, it may be realistic to factor in inflation when measuring returns on investments over a ten-year holding period. Between 1990 and 2003, the annual inflation, measured by the Consumer Price Index, hovered between 4 per cent and 13 per cent.

If inflation is brought into the picture, investors would have earned negative "real" returns in 24 of the 162 ten-year holding periods between 1990 and 2003. That is, there was roughly a one in seven chance of inflation actually shrinking the value of your investment, even as you patiently held on for ten years. Therefore, buying into equity and staying invested for ten years does not necessarily protect you from losing some of your principal.

Distorted by speculative bouts

But the above statistics present a very pessimistic view of equity investments, which may not hold good for all times to come. This is partly because there have been too many occasions over the past decade in which stocks have departed from their basic moorings in fundamentals and scaled unsustainably high levels on the back of stock market "scams".

In the decade from 1990 to the beginning of 2000, the ten-year holding period returns on the Sensex were at respectable levels; the returns were as high as 34 per cent per annum in the best year, but no lower than 18 per cent in the worst year. But the ten-year rolling returns fell sharply to single digit in mid-2001 and have remained there till date.

This can be traced largely to the speculative excesses of 1991 and 1992, when the Sensex climbed threefold in just nine months, to over 4200 points by March 1992. This was a period when stocks zoomed on the back of the Harshad Mehta scam, as liquidity, diverted from the banking system, poured into the stock market. The ten-year returns could continue to be low for investors who entered the market during the IPO boom of 1994 or during the Ketan Parekh-induced boom of 1999.

Select stocks: Islands of good returns

The rolling ten-year returns on the Sensex show that a buy-and-hold strategy may pay off six out of ten times, from the broad market point of view. But it has yielded better results for a select set of stocks.

For instance, the Hero Honda stock has generated uniformly high returns over a ten-year holding period. Between 1990 and 2003, the best ten-year rolling returns managed by the stock were a whopping 67 per cent (compounded annual returns). Even in the worst year, the ten-year returns on the stock never went below 19 per cent per annum.

So also with the Ranbaxy stock, which offered compounded annual returns of 58 per cent during the best ten-year holding period and as much as 21.5 per cent per annum, even in its worst ten-year holding period.

There are a host of other stocks where returns have not been as spectacular. Nevertheless, some of them have never yielded negative returns over a ten-year holding period.

After steadily offering annualised returns of 30-45 per cent between 1990 and 2001, the ten-year returns from the Hindustan Lever stock fell to 14-18 per cent in 2002 and 2003. But the stock has not had a single period of negative returns over a ten-year holding period. Glaxo, Bajaj Auto and ITC are also instances where investors have never lost money over a ten-year period.

Commodity and cyclical stocks

But that a stock may offer a negative return after a ten-year wait is a very real fear with commodity and economically-sensitive stocks. Tata Engineering appears to be a classic case. For investors who bought into it in September 1991, the stock had suffered a value erosion of 66 per cent in value by September 2001. The stock price plunged from Rs 202 to Rs 69 over this period. Investors who entered the Tata Steel stock in March 1992 have even more reason to be devastated.

The stock suffered a value erosion of around 80 per cent between March 1992 and March 2002, plunging from Rs 491 to Rs 75 between the two points in time.

Stocks such as L&T, Grasim and Reliance Industries have also displayed sizeable value erosion over a few ten-year holding periods.

In cyclical or commodity stocks, prices may go through significant swings based on underlying commodity prices or economic cycles.

Investors who enter such stocks when the cycle is in the ascendant may be faced with value erosion if their exit coincides with a down-cycle.

The ten-year rolling return on such stocks validates the view that a buy-and-hold strategy may not pay off.

Instead, investors may have to frequently review investments and book profits based on the outlook for commodity or business cycles.

But there are exceptions to both these rules. Gujarat Ambuja Cements and Hindalco have defied the generally-observed trend that commodity-oriented stocks may offer negative returns over a ten-year holding period, if investors get their timing wrong.

In the 13 years between 1990 and 2003, neither generated a negative return over a ten-year holding period.

Therefore, stock selection may play as important a role as timing in determining whether you made a good return on your stock market investment over a ten-year holding period.

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