PPF beat mkt over 20 years but here's why stocks are best

Moneycontrol BureauIn what would have likely sent long-term investors calling up their financial advisors anxiously, a recent article claimed that, over a period of 20 years, you would have been better off investing in the popular debt product, the public provident fund (PPF), rather than in the high-risk stock market (assuming the Sensex as a representative benchmark), which promises better returns.According to the report in the Economic Times, an investment in the Sensex in August 1994 would have yielded a “mediocre annualized return of 9.15 percent” while a similar investment in the PPF could have returned 10.46 percent annualized.The same newspaper had done a similar piece in April 2012, where it was claimed that an investment in the Sensex for a similar 20-year holding period would have yielded less than inflation, or many fixed-income products such as bank fixed deposits.While the primary data used for the analyses was correct, the articles suffered from various flaws, as pointed in a Moneylife piece recently.The earlier article did not take into account the effect of taxes or dividend (the first would have eaten into the FD’s return while the second would have added to Sensex’s), the more recent piece ignored the fact that since the PPF is a regular-investment vehicle, it would have been more apt to consider an SIP into the Sensex rather than assuming a one-time lump-sum investment. (Under the SIP method, as the Moneylife article points out, the Sensex would have returned 13.16 percent, compared to 10.01 percent from the PPF.)Then there was also the question that the article suffered from the fallacy of cherry-picking data. Other 20-year periods where stocks beat fixed-income products can easily be found if one looks up.The return on an equity benchmark is keenly tracked by investors and the financial media and it serves as a good instrument to compare with other investment avenues with different risk-return profiles.So when a supposedly-risky investment such as equity fails to beat the return offered by safer products (assured returns, little chances of default in cases where they have sovereign guarantee) over long holding periods, it calls into question the much-bandied-about notion of how stocks beat most other asset classes over the long run.So while investing in an asset class on the basis of a simple notion is riddled with folly, data does show that stocks indeed are generally a better asset class than stocks over the long term. (While the long term in itself is a rather fuzzy concept, according to most experts a period of seven to 10 years should be good enough.)And when stocks do fail to beat inflation, fixed income products or even yield a positive return over such periods, there is almost always a background to it taking place: the years preceding the start of these periods would have witnessed a superb bull run (even a bubble) that resulted in valuations get out of whack.The greater a period of outperformance in a bull market, the longer will be the resulting under-performance for the next several years.To get some perspective, HDFC Mutual Fund has compiled data of rolling returns for the Sensex for one-, three-, five- and 10-year periods going back to 1979 and has added valuations (using one-year forward PE) wherever available. (Rolling returns put out returns for each of those periods for each year, providing for a greater sample of data as well as cover roughly any investment done in any of those years.)According to the document available on its website, the Sensex showed negative returns for three five-year periods from out of 30 different time periods available: starting from March 1992, March 1994 and March 1998. Out of 25 possible instances, it was only once that the Sensex gave negative returns (March 1992) for a period of 10 years. In 1992, the Sensex was at 4285 while 10 years later, it stood at 3,469.But March 1992 should ring a bell for many investors – as we mentioned earlier, a great bear market almost always accounts for excesses of the bull market that precedes it – and between March 1988 and 1992, the Sensex went up from 398 to 4285, absolute returns of 976 percent (42 percent compounded), driven largely by the infamous Harshad Mehta scam.Similar periods of little returns -- the five years between 2008 and 2013 where the Sensex failed to go above 21,000, for instance -- bear out the trend. Between 2003 and 2008, the Sensex went up from 3,049 to 21,000.Valuations during the 1992 bubble reached a peak of 45 times trailing earnings. They stood at 28 times during the 2004-2007 real estate/infrastructure bubble. The mean average price-to-earnings for the Sensex stands at roughly 15 times.The catch: either invest when PE ratios are low, or invest via SIPs where your investments over the long term will average out your cost of buying closer to the mean PE.“It is very clear whenever you have invested in India below 15 price to earning multiples, over the next three and five years the returns have been extremely good,” ace fund manager and CIO of HDFC Mutual Fund told CNBC-TV18 in an interview recently.The document on the HDFC MF website proves this: there were six instances when the PE for the Sensex was trading below 15 times forward earnings. The returns for each of the following five-year periods stood at a minimum 12 percent and maximum 39 percent annualized.