Have equities delivered the best returns over the long term?

Juzer GabajiwalaVentura SecuritiesThe equity markets have certainly earned their reputation of being a roller coaster. Time and again, they have taken investors on a merry ride. In 2004 stocks nosedived post the elections, due to concerns that the formation of a coalition between the Congress and Left parties would be a challenge. Almost a decade later, during the most recent elections, the markets sky rocketed with optimism driven by a single party at the Centre. In between the two elections there was a relentless bull run that lasted till the global meltdown in 2008-09, after which a bear phase followed. And yet market pundits advise investors to stay invested for the long run if they wish to gain good returns from this asset class. We have come across many investors who claim that they are disappointed that equities have not delivered good returns even though they have remaining invested for time frames of as long as 5 -10 years. This has led us to see for ourselves if their claims are justified. First of all, we totally support the expectation that one should earn a higher reasonable return, if one invests in aggressive or risky asset classes for the long term. It is a law of finance: the higher the risk, the higher the expected returns should be, to compensate for the risk taken. So, an investment in equity should deliver better returns than an investment in a Bank FD or any other fixed rate instruments.The below table shows the returns generated on an investment of Rs. 1 lakh on a 5-year and 10-year basis:

Data as on Dec 31, 2015, *SBI 5 year rate, reinvested in Dec, 2010, ^NHB Residex for Mumbai.As seen from the above table, the value of Rs. 1 lakh invested in a Bank FD after 10 years is approx. Rs. 2.06 lakhs whereas the Sensex has generated a value of Rs. 2.77 lakhs during the same period. Hence, the Sensex has outperformed Bank FDs by approx. Rs. 71,000 or 26%. Nevertheless, investors could claim that they have not been rewarded reasonably, considering the risk they have borne by investing in equities. We would like to refute by pointing out that two important aspects have been ignored:1. You cannot compare apples with oranges: In the above table, equity returns are on a post-tax basis whereas Bank FD returns are on a pre-tax basis. Assuming an individual falls into the highest tax slab, this directly implies a tax of 30.9%. Hence, the post-tax return on Bank FDs would drop to 4.5% and 5.9% for 5 years and 10 years, respectively.In the same way, gold and real estate returns are on a pre-tax basis too and will be taxed at 20% with indexation. Due to the taxation effect, Gold returns will drop to 3.4% for 5 years and 11.9% for 10 years, respectively. Real estate returns will drop to 4.3% for 5 years and 7.8% for 10 years.Moreover, in the case of the Sensex returns, the dividends that were paid out by the companies have been ignored. The dividend yield was 1.5% p.a. and 1.9% p.a. for the last 5 years and 10 years, respectively. Taking this into account, the Sensex returns will improve to 6.5% for 5 years and to 12.7% for 10 years.Hence, by doing an apple to apple comparison, the revised table is as follows:Data as on Dec 31, 2015.As seen from the above table, the value of Rs. 1 lakh invested in Bank FDs is approximately Rs. 1.76 lakh after 10 years whereas the Sensex has generated a value of Rs. 3.30 lakh during the same period. Hence, the Sensex has outperformed Bank FDs by approx. Rs. 1.54 lakh or 47%, which clearly meets the risk-reward criteria of investing in equities.2. How many investors have actually invested in the Sensex? Investors would either have invested in shares or equity mutual funds but not generally in the index per se. The table below shows the percentage of equity-diversified mutual fund schemes that have out-performed / under-performed the Sensex and the maximum and minimum return on a 5-year and 10-year basis. It also shows the percentage of the AUM of equity-diversified schemes which out-performs / under-performs the Sensex:Data as on Dec 31, 2015.As seen from the above data, the weighted average return for equity- diversified mutual fund schemes on the basis of AUM is 12% and 16% compared to the Bank FD return of 4.49% and 5.87% on a 5-year and 10-year basis. The percentage of equity-diversified schemes that out-performed the index is 94% and 86% during the 5-year and 10-year period, respectively. Also, the percentage of AUM of equity - diversified schemes out-performing the index is 99% and 98% for 5 years and 10 years, respectively. The below table shows the top 3 and bottom 3 performers for the past 5 years and 10 years in the equity- diversified category:Equity Diversified Schemes for 5 YearsData as on Dec 31, 2015.Hence, there is clearly a significant reward that one earns by investing in specific stocks or equity mutual funds on a long term basis compared to other asset classes like Bank Fixed deposit, Gold and Real estate.Outlook for various asset classes:Gold: Considering the possibility of further US Fed rate hikes in 2016, as the US economy continues to improve, the prospects of Gold do not look very bright. Equity: The outlook for Indian equities, on the other hand, looks promising as indicated by various economic indicators like the low current account and fiscal deficits, falling interest rates, etc… Real estate: Real estate demand continues to be subdued and prices are expected to fall or remain stagnant during the coming years. Fixed rate instruments: These will always give steady returns and one would need to look at the returns vis-a-vis the inflation rate prevailing in the economy. Conclusion: Numerous studies have shown that equities do deliver better returns than other financial assets over long time frames. Here again, our investigation into whether equity investors have been suitably compensated for the risk that they have borne, has lead to the same conclusion. The key to successful equity investing is to choose a good set of stocks and stay invested for the long run. As Warren Buffet once said, “If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes”.