Diversification — parachute small investors need
It is tempting to infer the collective wisdom of the crowds milling around on the stock market predicting a glorious future for corporate India in the short term. Much as we wish for such a future, it would be worthwhile to consider some alternate explanations, and for small investors to adopt prudent strategies to protect themselves.
One, net investment by foreign portfolio investors since January this year has been $6.75 billion. On Wednesday alone, the inflow was $218 million. Two, ultra-low interest rates have a bias towards high valuations. When the rate of interest used to discount future earnings is low, ridiculously high price-earning ratios look more natural. Low rates of interest in the developed markets compel fund flows to emerging markets, to garner higher returns.
Interest rates have been kept low in India as well, because of the need to support economic recovery, after the pandemic-induced damage. That brings us to the third factor. A whole lot of conventional savings instruments favoured by the Indian middle class, such as bank fixed deposits and small savings instruments, no longer seem attractive. So, local investors are channelling their savings to the market, either directly or through mutual funds and insurance products that focus on investment in the market.
Four, Indian stock market indices have been rising even when the pandemic was wreaking havoc on the economy. Indian billionaires became bigger billionaires, thanks to the loosening of the link between the real economy and stock market performance. Five, overextended balloons have a habit of going pop. This is why a market veteran like Nilesh Shah suggests that investors might need to diversify away from stocks into assets such as real estate.
What the small investor needs is not tips on where Rakesh Jhunjhunwala is investing. She needs a savings pool that invests in diverse asset classes, including unlisted companies, artworks and global markets, and in assets with diverse risk-reward profiles in each asset class. We are yet to see such vehicles.