Saturday, August 21, 2010

Equity Investing: Weapons of mass inclusion:

Its human nature to demonise things, which one can’t understand. There are examples galore of ideas that were scorned at first, but embraced later. Equities suffer from the same malaise. Those who have not understood equities and investing in equities condemn them as gambling and write-off any contribution that they could play in the country’s development.

Financial inclusion is a much-talked about concept these days, but I think people have not understood it well. First, we should understand financial inclusion in the right perspective. There are many people who say that half of India is unbanked and they don’t have a bank account. Will it be financial inclusion if we are to open a bank account and put some small deposit in it? Most likely, the account will be defunct soon, and this helps no one.

I believe that meaningful financial inclusion can be done by participating in equities. Let’s understand how and why it is important. The Indian economy, as most of us agree, is likely to grow by 8.5-9% in real terms, which is 13-14% in nominal terms.

As has been the pattern over the past three decades, agriculture will grow at a slower pace of 2.5-3% p.a. (as land is the limiting factor) and the industrial and services sectors grow at a faster pace of 10-11% p.a. in real terms of over 15% in nominal terms. This reflects in the corporate earnings that have average growth of 18% per annum. At that rate, equity investments double in about four years time, whereas bank deposits earnings at around 6-7% per annum will take almost 12 years to double. In these 12 years, investments in equities would have grown 8-fold.

Also, returns on equities by way of dividend and capital gains are either tax-free or attract lower tax rate compared with interest income. Sadly, a dominant part of this prosperity and wealth creation, fuelled by a booming Indian economy, is being enjoyed only by large foreign investors or a handful of high net worth individuals (HNIs).

If a small saver can multiply thousand rupees eight times vis-a-vis two times, we can imagine the kind of difference it can make to his post-retirement life, standard of living and also to that of his future generations. It is a pity that today, only 4% of the savings of Indian households get invested in equities.

No doubt, there exists the risk of reckless investments. But this is where a professional investment manager would help. He is someone who understands that it’s incorrect to paint ‘equities’ in general as ‘very risky’. There are different grades of risk within equities.

While investments in small- and mid-cap companies have a higher risk-return payoff, investments in blue-chips and large-cap liquid scrips are considerably ‘safe’ while providing decent returns. A professional investment manager can understand people’s risk appetite and help channel investments to the right kind of companies for an acceptable rate of returns.


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