Is volatility good or bad? I’ve often seen that it is perceived to be an investor’s worst enemy. As per Marcellus Investment Managers, Indians have broadly 56 percent of their assets in bank fixed deposits and 23 percent in insurance-based instruments such as unit-linked and endowment policies. Just a paltry 7 percent has been invested in mutual funds, as per a report from the Reserve Bank of India (RBI) household finance committee.
It appears that investors don’t like volatility. They want guaranteed returns.
Chasing familiar assets
Investors broadly deal with four major asset classes, i.e., Fixed Income (FDs, Traditional Insurance policies, Bonds etc.), Gold, Equity and Real Estate. But why do investors like fixed income or debt instruments the most?
They aren’t that volatile. Despite interest rates on bank fixed deposits hovering at around 5 percent or even less, most savers are happily putting money here as they are getting a "guaranteed" return. Debt funds give better tax-adjusted returns, but they aren’t guaranteed.
What about insurance? Almost every second household in India would have invested in a traditional LIC policy at some point in time. But such policies give terrible returns; just about 5 percent. In their mind, somehow it has been ingrained that investment in insurance offers guaranteed returns (in the form of bonuses) over the long term.
Gold is another favourite. Most households have an annual ritual of buying physical gold at whatever the price levels are. But they seldom sell, even when gold prices are at a high. Though Gold has higher volatility too, most investors view the downside as an opportunity to accumulate more in the belief that prices will always trend higher.
Real estate is the favourite of all asset classes for many high net-worth and mass-affluent individuals. In quite a few cases, almost up to 99 per cent of their investible wealth is locked up in real estate. Why do we put so much money in a highly illiquid asset class? It’s part emotional and part cultural. A big reason is that there is no ticker (daily price or NAV available) put on the house. As a result, investors hold on for years and decades, thereby creating substantial wealth in the process.
Equities, less preferred
As a result of the above, equities get the least of our attention. Despite historically generating the maximum wealth over a long period, most Indians shun it mainly because of the highest volatility associated with it. Look at the below chart of drawdowns of an equity index from the top values every year. From the 1990s to 2008, it was common for equities to go down by 30-40 per cent. From 2011 to February 2020, people forgot about volatility in equities, only to be reminded in March 2020 about the true nature of equities.
As per AMFI data, only 30 per cent of the AUM stays invested for more than two years and perhaps only 2 per cent of that AUM would remain invested after 10 years. Let's understand through a real example.
Take a look at the above equity scheme’s past returns. If someone invested money in the last one year and saw a return of 33.93 per cent, 99 per cent of the investors would book profits thinking they have made a cool return in such a short period. But someone who has been investing for the last two years is very disappointed as he has made negative returns over two years. He must be cursing himself or his advisor for this state of affairs, thinking an FD would have been a much better option. And he would give up his patience and withdraw money vowing never to come back in the markets or at least in this particular fund. Since both kinds of investors exited, not even 1 per cent investors remain invested for the last 20 years and thereby missing twenty years of compounding double-digit growth.
Usually, the perception is, investors are not patient enough to hold for the long term. But as we have seen in investments such as PPF, FDs, insurance, gold and real estate, people do remain patient. Still, when it comes to equity, because they could see the current value of their portfolio on a daily or even minute-to-minute basis, they want to encash at the slightest volatility. And this is why most investors are interested in earning short-term profits but not interested in building long-term wealth.
Finally, what most investors forget is that it is in volatility that there is immense opportunity for wealth creation. As Warren Buffet says, "Be fearful when others are greedy and greedy when others are fearful." This maxim looks so simple on paper, but most challenging to execute.(The writer is the Managing Director and CEO of Etica Wealth Management)