“Examination of Efficient Market Hypothesis in Indian Stock Markets and behavioural patterns of Institutional and Individual Investors in India”
A Dissertation presented in part consideration for the degree of
“MA Finance and Investment”
Over 5 decades a lot of body of evidences have claimed that stock markets are efficient and it is not possible to beat the market consistently. In recent years, however, financial economists have increasingly questioned the efficient market theory. Market efficiency has an influence on the investment strategy of an investor If market is efficient, trying to find undervalued and overvalued stocks and trying to beating the market will be a waste. In an efficient market there will be no undervalued securities offering higher than deserved expected returns, given their risk. On the other hand if markets are not efficient, excess returns can be made by correctly picking the winners. This study examines the efficiency of Indian stock markets and shows that Indian stock markets are not completely efficient. There are existence of mispriced securities and opportunities for investors to outperform the market. As against many claims that it is not possible for any Mutual Fund to beat the market consistently, this study shows that, in India, active funds exist that have beaten the markets consistently. Behavioural finance is also important in making investment decisions in India and market participants are prone to irrationalities like herding behaviour, greed, relying too much on current information that causes market inefficiency and prices of securities to deviate from their intrinsic value. The study also outlines how investors can identify good investment opportunities.
TABLE OF CONTENTS
List of figures…………………………………………….……………… List of Tables……………………………………………..………………
CHAPTER 1: INTRODUCTION………………………………………… 1.1 Background of Indian stock markets………………………………... 1.2 Rationale of Research and Gaps in Existing Literature……………. 1.3 Aims and Objectives of the research……………………………….… 1.4 Research Questions and Propositions……………………………….. 1.4.1 Research Questions………………………………………………… 1.4.2 Research Propositions……………………………………………… 1.5 Topics Covered………………………………………………………… 1.6 Summary of this chapter……………………………………………....
1 1 3 5 6 7 7 8 9
CHAPTER 2: LITERATURE REVIEW…………………………………. 2.1 Introduction……………………………………………………………. 2.2 Efficient Market Hypothesis…………………………………………. 2.2.1 2.2.2 2.2.3 2.2.4 Implications of EMH………………………………………………... Supporters and Critics of EMH……………………………………... Behavioural Finance and EMH……………………………………… EMH and Investor’s strategy of Investment or Speculation…………
11 11 11 13 14 26 31 34 35 35 36 40
2.3 The Behaviour of Institutional Investors……………………………. 2.4 EMH in Indian context……………………………………………….. 2.4.1 Introduction………………………………………………………….. 2.4.2 Studies on Indian Capital Markets in context of EMH……………… 2.5 Markets are Efficient or Inefficient? Truce between the two?.............
1 Introduction…………………………………………………………….…. Participants and Materials……….……. 4..1 Secondary Research…………………………………………………. APPENDIX 2………………………………………………………………. APPENDIX 3……………………………………………………………….
109 123 124 129 130
.5.5.2 Research Setting……………………………………………………… 3.2 Primary Research…………………………………………………….1 Methodology Framework…………………………………………… 3.5. 3.1 Why are IIs not able to beat the market……………………………. Procedures. APPENDIX 1……………………………………………………………….2. 5.2 Qualitative Research and Quantitative Research……………………… 3.
102 102 104
REFERENCES…………………………………………………………….1 Sampling……………………………………………………………… 3.3 Research Participants and Procedures…………………………… 3. LIST OF APPENDICES………………………………………………….2. 5.2. 4.2 How can investors identify good investment opportunities…..2.3 Research Map…………………………………………………………….… 4.2 Research – Setting. 4. 3.1 Introduction………………………………………………………………. 3.2 Limitations of the study and future research…………………….4.1 Conclusions……………………………………………………….2.2.4 Research Methods………………………………………………………. 3.2.CHAPTER 3: METHODOLOGY…………………………………………… 3..….4.2 Findings to the Research Questions and Propositions……………… 4.……… 3.5.5 Rationale for interviews for research……………………………… 3. 3.5..6 Conclusion……………………………………………………………
43 43 43 45 47 47 47 48 48 49 52 53 53 59 61 61
CHAPTER 4: FINDINGS AND ANALYSIS OF STUDY……………….4 Data Analysis………………………………………………………… 3.5 Methodology and Data………………………………………….5. 3.5.3 Findings in context with literature
62 62 62 88 94 99
CHAPTER 5: CONCLUSIONS AND LIMITATIONS………………….
134 135 140 141
. APPENDIX 7…………………………………………………………….....APPENDIX 4……………………………………………………………… APPENDIX 5……………………………………………………………… APPENDIX 6…………………………………………………………….
LIST OF FIGURES
Data Analysis Model
Model of how the pressure is created on Fund Managers
LIST OF TABLES
Table 1 Research Questions 07
Findings on Efficient markets hypothesis
Findings on Information interpretation
Findings on investment strategy
Findings on existence of overvalued and undervalued stocks
Findings on motives for investment
Findings on behavioural finance
without their help I would not have got the opportunity to get the interviews of such knowledgeable people and conduct my research. She always took out time from her busy schedule to meet and discuss and give guidance on various aspects of this dissertation. She had always responded patiently to my demanding long emails and steered my work.
My sincere thanks to Mr. without whom.
. Arpit Agrawal and Mr.ACKNOWLEDGEMENT
An ongoing work of three months. guidance and valuable advice motivated me in my study and I am really thankful for all the efforts she has put in for making this study possible. Their time is greatly appreciated and is vital to this dissertation. It provided me the opportunity to meet very distinguished and knowledgeable people of the industry. completion of this dissertation has been a challenging task for me. First and foremost. Ashish Maheshwari. which was further extended by other professors. It had been a great learning and enriching experience and I truly enjoyed the entire process. Shahid Ibrahim’s lectures on Efficient Market Theory and Behavioral Finance were the main source of motivation for this study.
I would also like to thank all the professors who have imparted knowledge of different subject areas during my Master’s program. my supervisor. I would like to articulate my sincere gratitude to Ms Alyson McLintock. But all the efforts dedicated to it were worth it. I would also like to thank all the interviewees for their contributions. She has been my mentor throughout the project and her understanding and help made it possible for me to carry out this study. Her assurance. which proved beneficial for this dissertation. this research could not have been carried out.
All this would not have been possible without the help and support of some people. Mr.
Lastly. advised. At times I was not sure whether I will be able to complete my dissertation. All the while my parents made it possible for me to have the luxury of time to work and gave me encouragement that helped bring this dissertation to a successful completion. who helped me all the while and Vishal who proof-read my work and suggested many valuable changes. They supported and encouraged me all the while. but my mother encouraged me all along and kept me motivated.I must acknowledge as well my friends who assisted. encouragement and trust on me and my work made it possible for me to complete this course and this dissertation.
. They met all my needs during the dissertation. my sister who gave me motivation and encouragement all the while and also did proofreading for me and my brother who provided his help and fulfilled all my needs while I was working. Throughout the period their support. I owe a great deal to my parents who made it possible for me to pursue my Master’s degree. Her optimistic attitude is contagious. and supported my research.
1. the Indian financial system has been subjected to substantial reforms with far reaching consequences.Chapter 1: Introduction
CHAPTER 1: INTRODUCTION
The stock market appears in the news everyday and millions of people invest in the
stock market daily varying from professional investors to a layman. and wonder whether these investments are worth the price currently quoted in the stock market. This study endeavours to find out the reasons why the investors in India are not able to perform well in the market and also to unearth ways and strategies with which they can improve their performance. investors loose exorbitant amount of money in the stock market. The regulatory changes that have taken place during last one decade of financial sector reforms have resulted in financial markets becoming more efficient with respect to the price discovery mechanism and
. India currently leads in stock exchange development and is attracting investments from foreign investors. Despite the ubiquitous recommendations of the analysts. During last one decade. both large Foreign Institutional Investors and individuals. These reforms have helped in dramatic improvement in transparency level in financial markets including stock market. The investors in the stock market often try to gauge the true share prices of the companies they have invested in or of the prospective investments.1 Background of Indian stock markets
Amongst the developing countries.
Chapter 1: Introduction have helped the market to grow exponentially.).
Indian stock markets are gaining momentum in the world and are the fastest growing markets in the world amongst the developing countries.
. All these helped in better dissemination of information and hence possibly increased the level of efficiency in asset prices (Nath.d. The market has undergone substantial change due to introduction of hedging products like futures and options. Behavioural finance has not attracted much attention of Indian researchers and no study has yet made an attempt to study the behavioural patterns of investors and other market participants in Indian stock markets. Between July 1997 and February 2005. the BSE Sensex Index went from 4306 to 10980 and the NSE Nifty index rose from 1221 to 28541. International investors’ access to the domestic market has also helped in increasing liquidity. There have been significant changes in the regulations for smooth and efficient functioning of capital market in the country. The concept of developing a large order book in the stock market made the pricing of stocks more accurate and efficient and also resulted in bringing down the bid/ask spread benefiting the investors community as a whole. Despite this growth in the market. not much research has been conducted on Indian stock markets and the various ways in which the Indian analysts predict the movements of the Index and determine good investment opportunities. n. There is also a gap in the literature on Indian stock market as the studies that have been so far conducted have concentrated on quantitative techniques.
Despite so much effort put in by the investors. and also by allowing us to understand better how to locate profit opportunities for investment managers. The research can guide in portfolio allocation decisions.
. 2005) assert that research in behavioural finance has important applications. Shefrin argues that financial practitioners must acknowledge and understand behavioural finance.2 Rationale of Research and Gaps in Existing Literature
In spite of the conceptual and empirical evidences on the validity of Efficient Markets Hypothesis (henceforth EMH) in Indian stock markets. it is becoming difficult for fund managers to outperform the market consistently. a critical review of the literature indicates that very little pragmatic attention has been paid to behavioural finance in context of Indian stock markets. both by helping us to understand the kinds of errors that investors tend to make in managing their portfolios. the application of psychology to financial behaviour. which have not been uncovered through any researcher so far.Chapter 1: Introduction I have previously worked in a stock broking company in their research department and my work experience has been the main source of interest development in this research area and imparted me immense knowledge about the subject. in order to avoid many of the investment pitfalls caused by human error. This in turn has helped me to choose this topic for research
1. There are certain irrationalities the institutional investors (henceforth IIs) and individual investors succumb to that cause their performance to topple. Shiller and Thaler (in Anonymous.
Concisely. and corporate financial strategy. This research also investigates the human behaviour that guides stock selection. And only a small number of researches have made an attempt to find out the reasons for why the markets are not efficient. what commonly made errors they should avoid. then what investment strategies should be adopted by investors. security analysts.
The rationale of this research is to find out whether it is possible to outperform the market and if it is. this research attempts to find out ways to make money from the stock markets in India. no study has concentrated on finding out what the stock market participants perceive about the efficient markets theory. although a lot of statistical research has been produced to find out if Indian capital markets are efficient.
. which affects their performance in the market. financial services.Chapter 1: Introduction This study. Thus.
Moreover. It is important to understand what the market participants perceive because ultimately they make the markets and their perception would have an impact on the efficiency level of the market. therefore. this study has also made an attempt to find out what the market participants perceive about the efficiency level of Indian markets and the reasons for their perceptions. tries to understand and find out the errors and irrational behaviour that the investors. investment bankers and corporate leaders are subject to in Indian stock markets. money managers. how they can identify good investment strategies.
assess the behavioural patterns of market participants as gleamed from a review of the literature. It will also help the investors in identifying the irrationalities committed by them and how can they improve such irrational behaviour and also to understand what investment strategies should be adopted by them.3 Aims and Objectives of the research
This dissertation seeks to research the efficiency level of Indian stock markets and expert’s opinion on market efficiency. And therefore this study seeks to take views of experienced investors and money makers in the market.
1. It has also made an attempt to fill the gap in the literature and studies conducted on Indian stock markets.
. what actual investors think about the concept of efficient markets and its implications from their experience in the stock markets in India. who understand the stock markets. The main aim of the research project is to:
provide an evaluative summary of the efficiency of the Indian stock market. to assist the investors in their investment decisions (in context of Indian stock markets). assisting in their investment decisions.Chapter 1: Introduction The key research question that dominates this dissertation. however. This research will be of practical benefit to the researcher in her understanding of the markets and for the research department of the company she would be working with. is to find out.
Chapter 1: Introduction present an argument on the existence of overprices and underpriced stocks in the stock market. objectives of the research project are to discover:
the differences in the efficiency level between Indian stock markets and other developed stock markets (like USA and UK). how can they make money in the stock markets.
To achieve the ultimate goal. Precise key questions determine the focus and scope of study. and the analysis (Potter.
what irrationalities investors succumb to that causes their performance in the market to topple down.
why despite all the research undertaken by the IIs are they not able to beat the market?
1.e.4 Research Questions and Propositions
In order to achieve the research goal it is critical to clarify the key questions for which answers are sought and why are they important. 2003). provide an evidence on whether behavioural finance is important while making investment decisions in the stock markets. Therefore. the framework for study. It will help the researchers direct the literature review. tools and techniques. the research is broken down into several objectives. i. identify the strategies for investors to discover good investment opportunities.
4.2 Research Propositions
There are key issues emerging from the literature review of the topic area and previous studies and an examination of these issues have led to the creation of propositions (outlined in Table 2) for this dissertation.1 Research Questions
Table 1 outlines the key questions that this study seeks the answers.
TABLE 1 Research Questions Question 1 Are Indian markets as efficient as other developed markets like US and UK? Why? Question 2 Is the information that is disseminated in the market interpreted correctly by the investors? Are there smart arbitrageurs in the market who correct any mispricing in the stock and make markets efficient? Questions 3 What investment strategy should be adopted by individual investors? What factors affect their choice of investment strategy? Question 4 What irrational behaviour or emotional biases investors capitulate to that affects their investment decisions and also market prices and returns? Why are IIs not able to outperform the market? Question 5 How can investors identify good investment opportunities? Is technical analysis helpful in making investment decision?
1.4.Chapter 1: Introduction
1. which will be empirically tested through the research conduction.
With the use of explanations on investor behaviour propounded by BF theory. 8
. This literature will be sufficiently reviewed and assessed throughout the course of this paper.5 Topics Covered
To gain a solid foundation for studying these queries. In other words. the three forms of EMH and its implications. The chances of consistently outperforming the market are low. Markets cannot be completely efficient nor are they completely inefficient. Proposition 5 Behavioural Finance (BF) plays a vital role in understanding investor behaviour and making investment decisions. Therefore. albeit possible. investors can improve their returns in the market. Proposition 2 Stock markets price the securities correctly in medium to long term. behavioural finance and efficiency level of Indian stock markets. The topics discussed include
an explanation of EMH. Proposition 3 It is possible to outperform the market on a consistent basis and skill plays an important role in such performance. The academic sphere has produced a plethora of findings on validity of Efficient Market Hypothesis and its implications. over a long-term the price of a company’s shares reflects its intrinsic value.Chapter 1: Introduction TABLE 2 Research Propositions Proposition 1 Complete market efficiency is a utopian idea. prices of securities often deviate from their intrinsic value.
1. Proposition 4 Most of the people putting-in money in the stock markets are guided by the short-term speculative motives. a literature review will be produced.
the irrational behaviour of IIs. application of behavioural finance and behavioural patterns in Indian markets has been approached as follows:
1. It also outlined the research questions and propositions that will be used to meet the aims and the objectives of this study. argument on whether the markets are driven by investment or speculation. The key issue remains how to invest in the market and devise strategies to get good returns and identify the mistakes people commonly make in the market and learn from them. an outline of various studies conducted on Indian stock markets in context of EMH.Chapter 1: Introduction an explanation of the behavioural finance theory and its implications on investing. This was followed by a discussion on the rationale for the research and subsequent presentation of the aims and the objectives of this study.
The debate over whether the stock market is efficient or not is an ongoing one.6 Summary of this chapter
This chapter gave a brief introduction to the Indian stock markets and the way the markets have been evolving.
The topic of efficiency level of Indian stock market.
The research methods used to answer the research objectives are then outlined (Chapter 3). The author’s findings from the research undertaken are presented and there follows a discussion of what these findings mean for stock market participants and their investment strategies and investment decisions (Chapter 4) Conclusion and limitations of the study is presented (Chapter 5).
.Chapter 1: Introduction The literature on the EMH and behavioural finance and Indian stock markets is reviewed (Chapter 2).
Chapter 2: Literature Review
CHAPTER 2: LITERATURE REVIEW
2.1 Introduction The
amount of research on stock markets and predicting the stock prices and the
markets is overwhelming. There are various schools of thoughts on the subject, where on one side there are academics and scholars who can be divided between those who claim that stock prices or their future trend cannot be predicted and others who assert that it is possible to predict the prices of securities or future trend; and on the other side there are investors and traders in the financial markets who strongly believe that it is possible to beat the market and henceforth profit through careful investment strategies.
2.2 Efficient Market Hypothesis
One of the most popular and widely adopted theories, and the most criticised one, in the financial markets is the Efficient Market Hypothesis. EMH was first proposed by Samuelson (1965) and Mandelbrot (1966) and was successively popularized by Fama (1965, 1970) (Mandelbrot and Hudson, 2004; Zheng, 2005). Following Fama’s work many studies were devoted to examining the randomness of stock price movements for the purpose of demonstrating the efficiency of capital markets. One of the
pioneers of the EMH who has popularized this framework is Burton G. Malkiel
Chapter 2: Literature Review (Shostak, 1997)2. According to EMH, in context of equity markets, one cannot predict stock prices or their future trends. The theoretical basis of the EMH states that the investors behave rationally and, consequently, they value the securities consistently with their fundamental value.
Proponents of Efficient Market Hypothesis assert that:
“In an active market that includes many well-informed and intelligent investors, securities will be appropriately priced and reflect all available information. If a market is efficient, no information or analysis can be expected to result in outperformance of an appropriate benchmark.” (Fama, 1965)
The theory purports that there is perfect information in the stock market, which follows that any new information that becomes available to the market will be very quickly reflected in the prices (Fama, 1970). Thus, neither technical analysis (which is the study of past stock prices in an attempt to predict future prices) nor even fundamental analysis, (which is the analysis of financial information such as company earnings, asset values, etc. to help investors select “undervalued” stocks) would enable an investor to achieve returns greater than those that could be obtained by holding a randomly selected portfolio of individual stocks with comparable risk (Malkiel, 2003).
Work of Malkiel includes Malkiel (1973), Malkiel (1987), Malkiel (2000). See references for detail.
Chapter 2: Literature Review EMH is “endowed” with three distinct forms of “informational efficiency,” namely, the weak, the semi-strong, and the strong form of efficiency. The weak form implies a random walk (meaning stock prices are not predictable and patterns are merely accidental) of some form (part of Fama’s 1965 definition of efficiency) and that one cannot take advantage of the knowledge of historical price movements to earn superior returns on investments. In other words, technical analysis is of no use to earn superior returns. The semi-strong form implies that prices at any given time incorporate all publicly available information (including financial statements and news reports), i.e. when new information is released, it is fully incorporated into the price rather speedily. This is supported by the availability of intraday data-enabled tests which offer evidence of public information impacting stock prices within minutes (Patell and Wolfson, 1984, Gosnell, Keown and Pinkerton, 1996). And the strong form implies that prices at any given time incorporate all information, whether public or private (Frankfurter and McGoun, n.d.). Even insider information is of no use.
2.2.1 Implications of EMH
Fama persuasively made the argument that in an active market, that includes many well-informed and intelligent investors, securities will be appropriately priced and reflect all available information. The bottom line of the theory is that it is not possible to ‘beat the
market’ since there is no way to know something about a stock that isn’t already reflected in the stock’s price and
it is not possible to predict stock prices or their future trends. Any attempt to
try and predict any patterns or pricing movements is rendered ineffective and useless.
It may be surprising to note that myriad researches have been found to confirm the EMH. Unarguably. In an efficient market:
A strategy of randomly diversifying across stocks or indexing to the market. it is not surprising to note that EMH evokes multitude criticism and strong reactions particularly on the part of portfolio managers and analysts. carrying little or no information cost and minimal execution costs in order to optimise the returns. The odds of finding an undervalued stock would always be random (50-50 chance). the benefits from information collection and equity research would cover the costs of doing the research. no other theory in
. (Damodaran 2002)
From the implications of EMH. There would be no value added by portfolio managers and investment strategists.Chapter 2: Literature Review An efficient market also carries other implications for investment strategies mentioned below.2. would be superior to any other strategy.2 Supporters and Critics of EMH The debate about efficient markets has resulted in hundreds and thousands of empirical studies attempting to determine whether specific markets are in fact ‘efficient’ and if so to what degree. who view it as a challenge to their existence. Equity research and valuation would be a costly task that would provide no benefits. At best.
2. This is also known as passive investment strategy.
found that stock prices respond quickly to new information. stock-splits or changes in firms’ dividend policies. in 1978.Chapter 2: Literature Review economics or finance generates more passionate discussion between its challengers and proponents. conducted from the 1950s-70s. as emphasized by Schwert (2001) (in Constantinides et al. Their study also revealed that the market appears to anticipate the information. as has been stressed by Fama (1998). the returns
. confirmed that prices of US stock and other economic variables fluctuate randomly.
Malkiel (2003) and Eugene Fama (1970) summarize many early studies. and most of the price adjustment is complete before the event is revealed to the market. For example. and subsequently display no apparent strong trends following major events such as mergers.
Malkiel (2005) argues that markets are indeed efficient and provides evidence that by and large market prices do seem to reflect all the available information. Underreaction to news events appears as frequently in the data as over-reaction to events. Studies carried out by Working (1934) and Cowles and Jones (1937) which have been reported by Dimson and Mussavian (1998). noted Harvard financial economist Michael Jensen famously pronounced that “there is no other proposition in economics which has more solid empirical evidence supporting it than the Efficient Market Hypothesis.” while investment expert Peter Lynch claims “Efficient markets? That’s a bunch of junk. Event studies. Many of the predictable patterns seem to disappear as soon as they are discovered. that show that after trading costs are considered. April 1995). 2003). pioneered by Fama et al (1969). crazy stuff” (Fortune.
Kendall (1953) asserts that economists assume that time-series data on economic variables can be analyzed by making adjustment for long-term trends and examining the residual for short-term movements and random volatilities. Market participants can and do act irrationally. etc. He studied series of data on 22 UK stocks and commodity prices. that is why technicians say a study of the price movement is necessary (Anonymous I. The topic of behavioural finance is discussed later in detail. Because future stock prices can be strongly influenced by investor expectations. Technicians have long held that irrational human behaviour influences stock prices and claim to have ways of predicting probable outcomes based on this behaviour (Anonymous I. it suffices to note that behavioural finance essentially says that people are not the rational participants EMH makes them out to be. Proponents of technical analysis counter that technical analysis does not completely contradict the efficient market hypothesis. 2006)3. The data
See references for Anonymous I (2006) details. For present purpose. 2006). Technicians point to the new field of behavioural finance. track records. He concluded that “in series of prices which are observed at fairly close intervals the random changes from one term to the next are so large as to swamp any systematic effect which may be present.Chapter 2: Literature Review generated by many technical strategies underperform a simple buy and hold strategy.
. technicians claim it only follows that past prices can influence future prices. Technicians argue that EMH ignores the realities of the market place. namely that many investors base their future expectations on past earnings. Technicians agree with EMH in that they believe that all available information is reflected within a security’s price.
These empirical observations were called the “random walk model” or even the “random walk theory”. Future price can be predicted only once new information arrives and that information is unpredictable. Hence. Muller and Pictet (1992) state that the empirical studies confirm the efficiency of the major financial markets as well as the reflection of all information in current prices.Chapter 2: Literature Review behave almost like wandering series”. the Efficient Markets Hypothesis simplifies a complex reality. The correlation of price changes was close to zero (Dimson and Mussavian. one cannot predict the prices of stocks. there is lots of discontentment with the theory. which is apparent from the premises it is based on like the presumptions of homogeneous investor expectations. price changes from one period to the next are independent of past price changes. effective arbitrage.
A limited survey of the contemporary literature shows that criticism of EMH has gained both voice and momentum during recent years (Russel and Torbey. Dacorogna. and investor rationality. However. current price is the best forecast for future price.
When EMH was first introduced. Undoubtedly. Olsen. According to this theory. 1998). 2002). the studies based on EMH have made an invaluable contribution to the understanding of the securities market. The initial euphoria about the EMH has faded and that conflicting opinions on market
. Like all the theories. Therefore. an argument also raised by Stout (2004). the theory gained a lot of momentum in the market and received support from many researchers through their empirical studies confirming that markets were indeed efficient.
and markets would eventually collapse. to compensate investors for the costs of trading and information gathering. and researched yet again.Chapter 2: Literature Review behaviour and efficiency have provided the impetus for the current debate that markets are not efficient. Alternatively. the degree of market inefficiency determines the effort investors are willing to expend to gather and trade on information. They argue that perfectly informationally efficient markets are impossibility. non-degenerate market equilibrium will arise only when there are sufficient profit opportunities. merely noise. is a “violation of expectations”
Grossman (1976) and Grossman and Stiglitz (1980) go even farther. The supporters of the
An anomaly. If all arbitrage profits were eliminated. and arbitrage is costly. i. For example.
The furious debate on whether markets are completely informationally efficient has spanned more than four decades.. there is no profit to gathering information. then there would be no incentive for information search and acquisition. rebutted. in which case there would be little reason to trade. Who are the providers of these rents? Black (1986) gave a provocative answer: “noise traders. for if markets are perfectly efficient.e. Hence. Grossman and Stiglitz (1980) argued that the EMH contained a theoretical contradiction. The profits earned by attentive investors may be viewed as economic rents that accrue to those willing to engage in such activities.” individuals who trade on what they consider to be information that is. inefficiencies. with some well-known critiques and “anomalies4” exhaustively researched. in fact. in Thomas Kuhn's (1996) elegant phrase. the very activity that made markets efficient would wither away.
d. are small-firm effects. The mere existence of investors like Warren Buffett and John Templeton prove that it is possible to select stocks and earn a higher return than an index fund.
.). investment recommendations.what the above argument exactly means is. However empirical evidences have proved that there are investors in the market who have been consistently beating the market. there is a limit to their prevalence and impact because of opposing forces dedicated to exploiting such opportunities (Lo. many others sought to clarify this argument saying that . assert that the argument that EMH claims that investors cannot outperform the market is a myth and has been misinterpreted. Some of these systematic variations. And like them. and extraordinary returns to the time or the calendar effect5. One such well-known and known-to-be world’s
Appendix 1 provides a description of all the popular anomalies.Chapter 2: Literature Review EMH have responded to these challenges by arguing that while behavioural biases and corresponding inefficiencies do arise from time to time. is that one should not be expected to outperform the market predictably or consistently”.
In recent years. popularly known as anomalies. Jandik and Mandelker (n. 2004). many studies have demonstrated market inefficiencies by identifying systematic and permanent variations in stock returns.
Supporters of the Efficient Market Hypothesis gleefully point out that no investor in history has ever turned in a statistically significant out-performance of the market averages over a long period of time. amongst many others. “EMH does not imply that investors are unable to outperform the market. What EMH does claim. though. Damodaran (2002) and Clarke.
have outperformed the market averages with EMH-defying regularity (Hecter.persistent moneymaking opportunities that an unfailingly efficient market should long ago have arbitraged into oblivion. Between 1957 and 1969. Warren Buffet beat the Dow Jones Industrial Average by 22 percentage points (Hangstrom. Stocks with low price-earnings multiples (often called ‘value’ stocks) appear to provide higher rates of return than stocks with high price-to-earnings ratios. they fall on Mondays (Hecter. even after adjusting for risk. mostly disciples of the late Benjamin Graham. Bill Miller (of Legg Mason) is another such example who has beaten the stock market for 14 consecutive years (Heimer.
If the EMH were literally true. after all. 1988). 1997. p. Warren Buffet. More often than not. share prices rise in early January. Warren Buffett would not exist. They have found that small-company stocks consistently yield higher returns than large ones.Chapter 2: Literature Review greatest investor (mentioned earlier) is Mr. The wizard of Omaha and a handful of other high-visibility investors. In recent years scholars have documented a host of other anomalies . who made his fortune mainly through investments in the stock market. Year after year.
There have been several studies that suggest that “value” stocks have higher returns than so-called “growth” stocks. This finding is
Forbes World Richest People 2006 list
. 2005). as first shown by Nicholson (1960) and later confirmed by Ball (1978) and Basu (1983). 1988). 4). an American investor and the second richest man in the world6. The most common two methods of identifying value stocks have been price-earnings ratios and price-to-book-value ratios.
These investors’ strategies are to a large extent based on identifying markets where prices do not accurately reflect the available information. 114). 2006). investor Warren Buffett (Malkiel. there exist a number of investors who have outperformed the market over long periods of time. which explicitly implies that no such opportunities exist (Anonymous. the law of probability would suggest that a fairly large number are going to beat the market consistently.S.
. Kahneman and Riepe. in direct contradiction to the EMH.d. This demonstrates that in addition to ‘luck’. including Peter Lynch (formerly of Fidelity’s Magellan Fund). Warren Buffett. 2003). John Templeton (of Templeton funds). However. first expounded in their classic book on security analysis and later championed by the legendary U.). in a way which it is statistically unreasonable to attribute to good luck. John Neff (of Vanguard’s Windsor Fund) and Bill Miller (of Legg Mason) (Paquette et al. n.
Proponents of EMH claim that market efficiency implies that given the number of investors in financial markets. p. and it should be no surprise if one individual systematically beats all others. The finding is also consistent with the views of Graham and Dodd (1934).Chapter 2: Literature Review consistent with the views of behavioralists that investors tend to be overconfident of their ability to project high earnings growth and thus overpay for ‘growth’ stocks (for example. 1998). ‘skill’ is a significant input. not because of their investment strategies but because they are lucky (Damodaran. 2002.
more recent studies suggest the answers to these questions is no.Chapter 2: Literature Review Theorists often describe an efficient securities market as one in which prices “fully reflect” all available relevant information. does not imply that market prices respond to new information correctly or even that prices respond at all (Stout. 2004). Yet as Gilson and Kraakman (1984) pointed out. trouble. These first studies found that prices seemed to respond to new information almost immediately. and verify. and the like. Many types of information important to valuing securities seem to be
. process. understand. alone. What happens when new information becomes available but investors must invest substantial time. Efficient market. As a result it is impossible for every participant in securities markets to actually acquire. corporate mergers. In this regard. But consider the kind of information researchers initially used to test market efficiency. as we discussed earlier. within hours or minutes of an announcement. 2004). p. Merger announcements and stock split reports are widely disseminated and easy to understand (Stout. Another attack on the proponents of the theory is on their assertion that security prices reflect all public information. implies that the prices fully reflect available information. 363-65). 2004). or money to get it? What happens when the information is technical and difficult to understand? Do prices still change within hours or minutes? As Brealey & Myers note (2000. information is costly to obtain. many critics have raised a doubt and argued that informational efficiency. In the years immediately following the development of the EMH it was subjected to extensive empirical testing as researchers analyzed how quickly prices responded to public announcements of stock splits. and validate all the available information that might be relevant to valuing securities (Stout.
mathematicians and market practitioners find it difficult to believe that man-made markets are strong-form efficient when there are prima facie reasons for inefficiency including the slow diffusion of information. A good example is the widely-studied phenomenon of “post-earnings-announcement-drift. and the existence of
.Chapter 2: Literature Review incorporated into prices far more slowly and incompletely than the conventional account of market efficiency suggests. Researchers have been puzzled over these results. it may never be fully reflected at all (Stout.” An unanticipated announcement of increased corporate earnings tends to be followed by abnormal positive returns over the next several months. may take weeks or months to be reflected in price. the relatively great power of some market participants (e. 2004). while firms that announce unexpectedly poor earnings see abnormal negative returns over an extended period (this is known as postearnings-announcement drift). Information that is “public” but difficult to obtain. the possibility of informationally inefficient markets undermines the most vital proposition of the EMH that – ‘you can’t “beat the market” by trading on public information’. Therefore. Information that is easy to understand and that is popularized and iterated in the media may be incorporated into prices almost instantaneously.g. financial institutions).
Many economists. or information that is complex or requires a specialist’s knowledge to comprehend. Bernard & Thomas (1989) suggest drift is evidence that the initial price response to the new earnings information is incomplete. Indeed. and that the full implications of the new earnings information are digested by the market far more slowly than previously suspected.
it is also clear through many empirical evidences that information is not the only variable affecting security valuation. it is impossible to ascertain what a stock should be worth under an efficient market (Bergen. since the balance of investors value stocks differently.Chapter 2: Literature Review apparently sophisticated professional investors (Anonymous. information. indicate that valuation. If one investor looks for undervalued market opportunities while another investor evaluates a stock on the basis of its growth potential. and noise trading. The way that markets react to news surprises is perhaps the most evident flaw in the EMH. these two investors will already have arrived at a different assessment of the stock’s fair market value. theoretical arguments and supporting empirical evidence to show that security prices could deviate from their equilibrium values due to psychological factors. “Urgent questions about the stock market”. one argument against the EMH points out that. fashion and dissatisfaction are the obstacles in better pricing of equity shares. discussed in the next section. manipulation. Recent years have witnessed a new wave of researchers who have provided thought provoking.
. as Russel and Torbey (2002) argue that although it is true that the market responds to new information. 2006). HBR (1964) in its editorial article entitled. 2004).
Another problem with EMH is that it assumes that all investors perceive all available information in precisely the same manner. Therefore. fads. The numerous methods for analysing and valuing stocks pose some problems for the validity of the EMH.
Summers (1986) opined that financial markets were not efficient in the sense of rationally reflecting fundamentals. the bubble starts dominating fundamentals. Campbell et al (1997). 2003. as time increases. Lo and Mackinlay demonstrate that there is momentum in the stock market and that the random walk hypothesis can be rejected (Malkiel. such deviations can be used by investors to fashion winning investment strategies. and in some circumstances inefficient. or there would be no incentive for professionals to uncover the information that gets so quickly reflected in market prices. Shiller (2000) documents the behavioural factors that lead to investment bubbles and also argues that future
. Fama and French (1988) in their paper on permanent and temporary components of stock prices found returns to possess large predictable components casting doubts about the efficiency of the stock market. a point stressed by Grossman and Stiglitz (1980). for example conclude that stock markets are atleast partially predictable. DeBondt and Thaler (1995) survey the body of work on behavioural finance and suggest that stock prices often deviate substantially from their fundamental values. In their view. economists and researchers have pointed out that the market cannot be perfectly efficient. further. In their survey of the econometrics of financial markets. the proportional change in stock prices is an increasing function of time and therefore predictable. Several theorists. p.Chapter 2: Literature Review A considerable body of academic work on asset pricing has stressed that stock markets are somewhat predictable. which can be tested by regressing the proportional change in stock prices on time.9). Blanchard and Watson (1982) show that when the bubble is present. I.
) illustrate Dreman’s (1979) argument for behavioural finance.7).
2. 1982) strongly breached the concept of efficient market and threw light on many aspects of human behaviour which showed that markets rather behave inefficiently. Tversky. In the 1990’s.2. emergence of behavioural finance with its discovery of systematic biases in human judgment leading to doubts that human beings can be counted on to take a strictly rational approach to decision making (Kahneman.d. proposing that investors react to events in a fashion that consistently overvalues the prospects of the “best” investments and undervalues those they consider the “worst”.
Frankfurter and McGoun (n.
Many investors have long considered that psychology plays a key role in determining the behaviour of markets.Chapter 2: Literature Review stock prices are to some extent predictable.3 Behavioural Finance and EMH
Market efficiency has been challenged by behavioural finance. Slovic. 2005). Lintner (1998) defines behavioural finance as being ‘the study of how humans interpret and act on information to make informed investment decisions’ (p. Dreman (1979) builds his argument on psychological factors.both rationally and not” (Nocera. Appendix 2 lists the predictions made by EMH and the empirical evidence on the former. described in a recent New York Times article as the “brand of economics that tries to explain the market in terms of the way humans behave . Dreman and Berry (1995) summarize the following predictions of the overreaction hypothesis:
and reinforcing events (negative surprises on “worst” stocks and positive surprises on “best”).Chapter 2: Literature Review 1. and negative surprises on “best” stocks). For long periods “best” stocks underperform while “worst” stocks outperform the market. it is possible for the stock market to remain for long periods at levels far removed from intrinsic value (Frankfurter and McGoun. either overestimating or underestimating quarterly earnings after positive or negative surprises. Michaely. As a result. 2. n. Bernard and Thomas (1990) and Abarbanell and Bernard (1992) show that financial analysts under react to earnings announcements. find price responses to dividend cuts and/or initiations to continue for an excessively and irrationally long time. Ikenberry. discount information in the rational manner suggested by theory. Thaler and Womack (1995). 3.). Positive surprises boost “worst” stock prices significantly more than they do for “best” stocks and negative surprises depress “best” stock prices much more than they do for “worst” stocks. Investors do not.
Several event studies have shown evidence of under-reaction in which the market response to new information appears to be too little or too late.d. Lakonishok and Vermaelen (1995) contend that investors under-react to firms’ share repurchases. There are two distinct categories of surprises: event triggers (positive surprises on “worst” stocks. Event-triggers result in much larger price movements than do reinforcing events. in fact.
In fact. Here. as well as technically based momentum strategies.people suspending their private judgments and acting on public information.
. argue that for anyone who’s been through the Internet bubble and the subsequent crash. rather than being anomalies. 1999). investors are subject to a fear that others know more or have more information. buying stocks whose prices have started to rise. for example. some stocks will be mispriced and the market will be inefficient (Thorley. or buying stocks whose prices have recently dropped. to overreact to news. As a consequence. the EMH is hard to swallow. When a market is moving up or down. may cause investors. They explain that. researchers have regularly reproduced market behaviour using very simple experiments. is a good description of herding .
In fact. This belief motivates basic fundamental analysis. and the irrationality is pervasive enough. Two other common behaviour outlined by behavioralists are:
The Herd versus the Self: Herd instinct explains why people tend to imitate others.Chapter 2: Literature Review Other human frailties. like the tendency to place too much weight on the most recent data. in consensus. and thus market prices. On the other hand. irrational behaviour is commonplace. The point is that if some investors are irrational. Predictable overreaction allows for a market timing strategy of buying on bad news. investors feel a strong impulse to do what others are doing. another assertion is that all but a few investors neglect certain obscure stocks. behavioralists.
all newcomers choose the same restaurant: they choose the more popular one irrespective of their own information.
. It is 6:00 PM. to reduce their risk of underperforming the benchmark. Both restaurants are empty. irrespective of valuation. After a while.and chooses one of them. There is no menu outside. A tourist comes down the street. The scene repeats itself. sees how many patrons are already inside by looking through the stained glass windows these are Alsatian winstube . another tourist shows up.Chamley (2004) Lamont (2004) seeks to explain herding in a simple model in which uninformed traders (dumb money) overwhelm informed traders (smart money) in speculative bubbles. looks at each of the restaurants. For instance. . Hoguet (2005) explains as markets rise.
Investors tend to place too much worth on judgments derived from small samples of data or from single sources. 2002). investors are known to attribute skill rather than luck to an analyst that picks a winning stock (McClure.Chapter 2: Literature Review Two restaurants face one another on the main street of a charming Alsatian village. After a while. investment managers who underweight a market buy into it. with new tourists checking on the popularity of each restaurant before entering one of them. and goes into one of them.
Chapter 2: Literature Review In fact, the so-called herding behaviour of stock market players has been commonly found to take place in financial markets. Hoguet (2005) asserts that herding is particularly common in emerging markets. He alleges that the performance of Japanese stocks in the 1980s and NASDAQ in the 1990s are two prominent examples of overshoots. In emerging markets, Taiwanese shares fell 75% in six months in 1990.
Human patterns of less-than-perfectly rational behaviour are central to financial market behaviour, even among investment professionals. Julius Caesar said “Men willingly believe what they wish7.” His insight was on target. This statement has been well elaborated as an explanation for the stock market crashes and bubbles by the behavioralists. It has been shown in a number of psychological studies that people suffer a wishful thinking bias, that is, they overestimate the probability of success of entities that they feel associated with. Wishful thinking bias appears to play a role in the propagation of a speculative bubble. After a bubble has continued for a while, there are many people who have committed themselves to the investments, emotionally as well as financially (Shiller, 2001), which further causes the prices to deviate unjustifiably from their intrinsic value and causing this process to continue for a longer time. By the time it is realized that the prices are irrational, the market has crashed and people have lost significant amount of wealth.
Julius Caesar, De Bello Gallico, pp. iii, 18.
Chapter 2: Literature Review Behavioural finance certainly reflects some of the attitudes embedded in the investment system. Behaviourists will argue that investors often behave irrationally, producing inefficient markets and mispriced securities - opportunities to make money. That may be true for an instant. But, consistently uncovering these inefficiencies is a challenge. Questions remain over whether these behavioural finance theories can be used to manage money effectively and economically. The irrationalities present amongst the Indian stock markets participants have been explored in the findings and analysis sections.
2.2.4 EMH and Investor’s strategy of Investment or Speculation
‘The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists’. - Graham (2003)
The EMH and John Maynard Keynes’ (1936) philosophy represent two extreme views of the stock market. EMH is built on the assumption of investor rationality, which is in stark contrast to Keynes’ philosophy in which he pictures the stock market as a ‘casino’ guided by ‘animal spirit’. He argues that investors are guided by shortrun speculative motives. They are not interested in assessing the present value of future dividends and holding an investment for a significant period, but rather in estimating the short-run price movements (Russel and Torbey, 2002).
Chapter 2: Literature Review There is a line to be drawn between investment and speculation. Graham (2003), in his bestseller that made the foundation of many great investors’ investment strategy of value investing including Warren Buffett, clearly made a distinction between an investor and a speculator. In his definition, ‘an investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return’. Operations not meeting these requirements are speculative (p. 29). The thorough analysis that he insisted upon was explained as ‘the careful study of available facts with the attempt to draw conclusions therefrom based on established principles and sound logic’.
Graham says, investors judge ‘the market price by established standards of value’, while speculators ‘base [their] standards of value upon the market price.’
In 1999, at least 6 million people were trading online and roughly a tenth of them were ‘day trading’, using the Internet to buy and sell stocks at a lighting speed. It somehow became an instant way to mint money. By pouring continuous data about stocks into bars and barbershops, kitchens and cafes, taxicabs and truck stops, financial websites and financial TV have turned the stock market into a non-stop videogame. The public felt more knowledgeable about stock markets than ever before. Unfortunately, while people were drowning in data, knowledge was nowhere to be found. Stocks had entirely decoupled from the companies that issued them – pure abstractions, just blips moving across a TV or a computer screen (Zweig, J. in Graham, 2003, P. 39).
also known as ‘day-trading’ or ‘jobbing’. He has long felt that ‘the only value of stock forecasters is to make fortune tellers look good’ (Hangstrom. 1997. It would be more a matter of luck rather than skill out of which they can make the money in the market.Chapter 2: Literature Review For the capital market comprising for speculators. examples of such behaviour are the so-called Bubbles. This causes the prices of the stocks to deviate from their fundamental values and sometimes this deviation is so broad that it may cause a crash in the market.
. seeing ‘truth’ in prices. Traders make the short-term market efficient because they trade on rumours and news and are very close to the source of this information. but they don’t settle on any correct judgment of intrinsic value. He cannot predict the short-term market movements and does not believe that anyone else can. However traders seem to be quite inept at pricing stocks properly. with majority of them conducting their trading on a day’s basis. They move the market rapidly upward or downward when something is announced. the theory of EMH would hold to a great extent. Their interest is in the short-term price movements in the market. 51). p. They are the people who trade in the market on the basis of the ‘tips’ or the hot ‘tips’ that is readily available everywhere. Most traders don’t care about intrinsic value anyway.
Speculators comprise a big chunk in the stock market. They move stocks up or down. in the sense that they cannot exactly predict the prices. Buffett also supports this argument and says that he gives zero credence to market predictions.
. or. Another reason that the differences are so small is that institutional investors do not feel that they have the authority to make trades in accordance with their own best judgments. active managers and other money managers not able to beat the market. are not willing to pay high management fees unless they do so. reasons that could be justified to a committee. These effects dilute the advantages that institutional investors naturally have. The clients expect them to trade frequently. One reason that institutional investors may not do better is that they feel that they are dealing with clients who have expectations of them that make it difficult to pursue their own best judgment. Their obeisance to conventional wisdom hampers their investment ability (Shiller. and with all the resources and skills they have. Damodaran (2002) also argues that there seems to be little evidence of money managers being able to exploit the socalled profiting opportunities to beat the market. why are the analysts. which are often intuitive. anomalies exist.3 The Behaviour of Institutional Investors
Proponents of EMH have long been challenging the performance of institutional investors and have been arguing that if markets are not efficient and there are opportunities of profiting above the market returns. The clients expect them to invest in accordance with certain fads. and that there is persistence of performance among investors. Nearly all mutual and pension funds also fail to beat the market on a consistent basis. 2001).Chapter 2: Literature Review
2. at least.
The recent empirical literature also suggests that institutional or professional investors have been able to do a little better than the market. that they must have reasons for what they do.
India has a mature stock market. Ostensibly. published by IFC). 2006).4 EMH in Indian context
2. the stock exchanges were forced to improve the quality of their trading and settlement procedures in accordance with the best
. maintains that portfolio managers do not consistently follow any one strategy for investment. this opening up resulted in a number of positive effects.1 Introduction
Despite being a developing economy. The first stock exchange in India. the Indian stock markets are characterized as the emerging markets. established well over a hundred years ago. has more than 6200 listed companies (Emerging Stock Markets.
2. However. This number is exceeded only by the NYSE and is much larger than number of listed companies in other stock markets in the world (Barua and Varma.4. But they rather jump from one strategy to another.Chapter 2: Literature Review Another explanation for the institutional investors not able to beat the market or atleast not so after considering their research and other expenses. both increasing their expenses and reducing the likelihood that the strategy can generate excess returns in the long-term. as offered by Damodaran (2002) and also supported by other researchers. 1990. First.
India liberalized its financial markets and allowed Foreign Institutional Investors to participate in their domestic markets in 1992. established at Bombay in 1885.
rather than simply taking a snapshot of the market at a particular point in time (Tamakloe. Returns were computed
. the information environment in India improved with the advent of major foreign institutional investors (FIIs) in India. the less-informed investor characteristic does not imply much in Indian case. thin trading. there have been a number of studies on the question of efficiency. emerging markets by their very nature change rapidly through time.
Although India is an emerging market. this will impact on both the informational and allocational efficiency of the markets. possibly less-informed investors with access to unreliable information and considerable volatility.4. Mallikarjunappa (2004) examined the efficiency of the Indian stock market in the semi-strong form using event study. Emerging Markets are typically characterized by low liquidity. Mumbai (BSE). The dismantling of barriers to the flow of capital both within the country and from external sources will cause changes in the intuitional and regulatory environments. In addition. but whether they use all available information for investment purposes is not known. His study was based on sensitive index (Sensex) based companies of BSE. 2003). In turn. Second. The results from the studies are mixed.
2.2 Studies on Indian Capital Markets in context of EMH
For emerging Indian stock markets.Chapter 2: Literature Review practices of the world. Vaidyanathan and Gali (1994) in their test for the existence of weak form of efficiency of the Indian capital market have provided supportive evidence for the weak form of efficiency in the Stock Exchange. Investors have availability to all public information.
to name a few. The broad conclusion of his study and tests show that the Indian market does not conform to a random walk and hence rejects the Random Walk Hypothesis. Gupta (1985) also indicate weak form of market efficiency.Chapter 2: Literature Review using the price data of companies and the Sensex. They say that such evidence casts serious doubts about the level of market efficiency (semi-strong form). have found the Indian stock market to be efficient in the weak and the semi-strong form. Patel (2000) also reported the presence of strong size effect in 9 out of 22 emerging markets including India over the period 1988-1998. Poshakwale (2002) examined the random walk hypothesis in the Indian stock market (i. Their research finds out that a strong size effect exists in the Indian stock market during the period 1990-2003. This conclusion arrived at using the conventional method of testing market efficiency is in line with similar works in markets in the developed economies. He also asserts that his results are largely consistent with the previous research in the US and UK. Mohanty (2001) documented the presence of strong size effect in Indian stock market over the period 1991-2000 using the market capitalization as the measure of firm’s size. Studies by Barua (1981). Ramachandran (1984).e. The results of his studied showed that the Indian market is not efficient in the semi-strong form.
. Barua (1981). Sharma and Kennedy (1977). Sharma (1983). Ray (1976).
Sehgaland and Tripathi (2005) have found the evidence of the size based investment strategy providing statistically significant extra normal returns in Indian stock market. BSE).
Mr.Chapter 2: Literature Review Behaviour of institutional investors in India can provide an explanation of the cause of some inefficiency in the Indian stock market. In the case of a liquid stock. like the impact costs. she finds that FIIs tend to herd in the
. Since the institutional investors do not pay much attention to small-stocks. in stock prices in the short run. there is not much availability of equity research in such stocks. once remarked that in India. the Chief Investment Officer of Jardine Fleming. By investing only in liquid stocks. Thus these stocks do not generate much interest in the market and remain undervalued causing inefficiency and profit opportunities. Pitabus (2001) through his research on ‘Efficiency of the Market for Small Stocks’ found out that in India institutional investors prefer to invest their money in the liquid stocks. the large investors are able to reduce certain transaction costs. mild though it is. for the foreign institutional investors “Big is Beautiful” (Mohanty. however. one can easily buy or sell a large number of stocks without affecting the price much. discerns contribution of bubbles. Using both daily and monthly data. In the study conducted by Pitabus. Batra (2003) provides evidence of the herding behaviour in the Indian markets.
Barman’s (1999) study finds that fundamentals rather than bubbles are more important in the determination of stock prices in the long run in the Indian market. if an investor wants to buy stocks of small companies he has to generate the equity research himself. the large investors usually invest only in the large stocks. Hence. which entails costs. it was found that there is a very high correlation between liquidity of the stock and the size of the company. which the investor might not be willing to pay. Hence. U R Bhat. 2000).
Obaidullah (1991) used sensex data from 1979-1991 and found that stock price adjustment to release of relevant information (fundamentals) is not in the right direction. not much research has been conducted on Indian capital markets. even in Indian market no consensus has been reached about whether the markets are efficient or not. There is more speculation by investors rather than investment orientation. The study indicated that equity markets suffer serious inadequacies as a mechanism for raising capital. though appear to be efficient over a longer run period.
Like other markets. as can be seen from the studies above. In context of behavioural finance. implying presence of undervalued and overvalued stocks in the market.Chapter 2: Literature Review Indian market and the herding measure being high for the monthly horizon. Gokaran (2000) has studied the financing patterns of the corporate for growth in India. Barman and Madhusoodan (1993) in their RBI Papers found that stock returns do not exhibit efficiency in the shorter or medium term.
2004). The efficient market theory is flawed. (2004) . unfortunately. By assuming efficient markets. As a result. the market will always overvalue and undervalue common stocks due to the human emotions that drive it. There are simply too many examples of stocks that were discovered by a great manager before anyone else knew what was going on. the EMH has literally spawned much recent research and has become entrenched as a truth in the minds of many academics.
. Even Burton Malkiel. But we also should think twice before assuming markets are even informationally efficient”.5 Markets are Efficient or Inefficient? Truce between the two?
“I think that our gurus proved the point without a doubt. academics can conduct empirical investigations and come to robust conclusions. But.Chapter 2: Literature Review
Market efficiency is always a goal in the marketplace. However. one of the most lucid proponents of market efficiency. we know that markets have made egregious mistakes’ (Malkiel 2003. We all want to get the value we pay for. agrees that ‘after the fact. p. as mentioned earlier. the golden goose may not to be so golden (Downe et al.” – Peter Tanous (1997)
“Most of us probably would do better to buy an index fund or throw darts at the Wall Street Journal. 61).
despite the increasing use of computers.Chapter 2: Literature Review Bergen (2004) argues that although it is relatively easy to pour cold water on the EMH. Much of EMH is untestable. most decisionmaking is still done by human beings and is therefore subject to human error. and even translate such analysis into an immediate trade execution. people will continually search for the sure-fire method of achieving greater returns than the market averages. According to Roll (1997). Given the right power and speed. Even at an institutional level. 2004). Even after three decades of research and literally thousands of journal articles. unverifiable and non-science and thus cannot be confirmed or negated through rigorous assessment. the theory of EMH is not science and researchers have argued that it is not possible to test the efficiency of a capital market with complete accuracy. It is disarmingly simple to state. trades and corporations. This has resulted in protract disputes between those who supported the EMH and those who did not (McMinn.
Also. has far-reaching consequences for academic pursuits and business practice and yet is surprisingly resilient to empirical proof or refutation. investments are becoming increasingly automated on the basis of strict mathematical or fundamental analytical methods. “EMH (is) one of the most controversial and well-studied propositions in all the social sciences. While the success of stock market investing is based mostly on the skill of individual or institutional investors. the use of analytical machines is anything but universal. some computers can immediately process any and all available information. With the rise of computerized systems to analyse stock investments. economists have not yet reached a consensus
. its relevance may actually be growing. However.
Chapter 2: Literature Review about whether markets . 1997).particularly financial markets .
. 1999).are efficient or not” (Roll.
The fury of the market efficiency battle is so great that one can easily miss Fama’s (1991) statement that “market efficiency per se is not testable” (p. 1575) (in Statman.
More formally. 1995). Considering the broad based nature of the research and the need to conduct in-depth analysis. ‘no matter how statistically powerful a nomothetic (quantitative research) finding is.1 Introduction Methodology is a framework within which a research is conducted (Remenyi et al. the rationale of those data collection methods and a discussion of the validity and reliability of these research methods.
1995). It also outlines how the whole research was carried out.
The aim of this chapter is to illustrate the research approach adopted. including how data were collected. it can never definitively predict experience and action of the individual person (qualitative research)’ (quoted in Nau.
.Chapter 3: Methodology
CHAPTER 3: METHODOLOGY
3.2 Qualitative Research and Quantitative Research
Research is a systematic investigation to find answers to a problem.
3. as Fraenkel (1993) puts. The two main broad categories that any research comprises of are Qualitative Method and Quantitative Method. Methodology and a good structure formulation can ensure a good logical flow of information and helps reduce complexity within a research. the qualitative research technique seemed to be the most suitable for this research work.
The history and logic suggests that if everyone would have been able to outperform the market consistently and it would have been an easy job. The reason being that the statistical or the quantitative perspective always looks at the sample and concludes its results on the basis of what the majority holds. But this is not the case. everyone in this world would have been rich and all the problems would have been solved. research conducted showed that although there has been a lot of statistical research produced on the validity of EMH in Indian capital markets no study attempted to find out what market participants believe about the theory. i.
The aim of the dissertation is to explain the efficiency of Indian stock market and how can investors beat the market. And in order to find out this.Chapter 3: Methodology The research methods used in this study are mainly qualitative. However. Albeit the quantitative studies suggest
. Firstly. However. qualitative research was the only method that could be used effectively. qualitative research method is most appropriate for following reasons:
There have been quantitative research and statistical tests conducted on the Indian stock market to find out if the markets are efficient or not. no study has yet tried to look on the topic area from the qualitative perspective. the aim has been to find out if it is possible to beat the market. After evaluating the topic and aim of research. in this research.e. There are two main reasons for this. if it is possible to beat the market. which in my opinion is an equally vital area of study.
the researcher is more likely to be involved with the people. Thus. which is not possible in a quantitative study.
. particularly in the Indian capital markets. to the conclusion. there are people who have proven the theory wrong by the exceptional returns on their investment. qualitative research methodology is the most relevant method for data gathering and analysis. qualitative research would help to meet the objectives as through this research rather than being an outside-researcher looking in.Chapter 3: Methodology that markets are efficient.3 Research Map
Figure 1 outlines how the whole research was done and illustrates all the stages of the research from the beginning.engaging perhaps in ‘participant observation’. which she intends to work with. Arihant Capital Markets Limited. it is important to study this subject from a different stance. organization . Through this research the researcher aspires to improve her understanding and broaden her knowledge of the capital markets and the participant’s behaviour in context of Indian capital markets. the researcher also aims to improve the Research Department of the company. With the help of this research. Thus. The quantitative study and statistical methods will not be helpful in identifying these factors. In order to understand the behavioural factors that affect the capital market participants and market as a whole. which this research is endeavouring to accomplish.
The collected data was then evaluated and finally the research was concluded on the basis of the research and analysis part. which began with secondary research and then at a later stage primary research was conducted.Chapter 3: Methodology FIGURE 1
The key research question was selected.
Author indicates the person who carried out this research
. then the research process started and information gathering was done.
4. etc. some articles on Indian capital markets and also the Indian analysts’ view have been used in the data gathering and analysis stage.) and is collected specifically for the study at hand. interviews.1 Secondary Research
Secondary data is data that has been collected for some other purpose and can be used to answer research questions (Saunders et al. secondary data has a restricted application. secondary research has assisted in getting information on specific subject problems.4 Research Methods
The method tools chosen for the research were appropriate as they helped in obtaining valuable information and knowledge. developed theories and research questions.4. 2003). In answering the research questions and meeting the objectives of this dissertation.2 Primary Research
Primary research is data that is actually collected from the natural world (including experiments. this study has used the qualitative research technique of
The secondary research conducted mainly falls into the heading of the literature review.Chapter 3: Methodology
In order to acquire profound knowledge and information of relevant areas of research.
3. case studies. However. The secondary research also aided in the creation of questions for interviews. For data collection.
discussed in detail in next section. Primary research tools were used because they provide the opportunity to interact with people and obtain desired information.5. 2003).
3.1 Methodology Framework
This section outlines the Methodology Framework.
Figure 2 basically provides a broad framework of the methodology (taken from Saunders et al.Chapter 3: Methodology direct communication with the research participants through interviews. the use of particular strategies and tools for data gathering and analysis and the rationale for the choice of methodology for data gathering and for data analysis through a diagram.5 Methodology and Data
. that is discussed in the next section. i. Interviews were conducted to get the answers to the research questions and acquire profound information from the experts and professionals in the investment arena in Indian stock markets.e.
Primary research was pivotal to this research and was the main source of data gathering.
As defined by Khan and Cannell (1957. individual and other institutional investors (I I’s). interviews are the predominant means of data collection.2 Research – Setting. mutual fund managers. for qualitative research methods. the research method employed in accessing primary data was semi-structured face-to-face interviews and telephonic interviews with capital market analysts. interview is “a conversation with purpose”.Chapter 3: Methodology FIGURE 2
. pp. Procedures. Participants and Materials
As suggested by Sanger (1996). 149).
In order to get the most valuable information and well-focused comments and advices on the specific research topics from the experts and professionals.5.
Chapter 3: Methodology An interview is advantageous (Easterby-Smith et al. and from which the interviewer or interviewee may diverge in order
. In fact. 2002.
Britten (1995) explains that semi-structured interviews are conducted on the basis of a loose structure consisting of open ended questions that define the area to be explored. 2003).. which might not have been possible without a semi-structured interview. For example. But only when asked to think of some other such behaviour did they actually reflect over the question and provided further examples of such behaviour. Healey. or build on their responses (Saunders et al. at least initially. 1991):
Where there are many questions to be answered When the questions may be open ended Where the order of questioning may need to be varied
All the above mentioned points justify the selection of interviews for data gathering in this research project. when the interviewees were asked to outline some irrational behaviour of investors most of them initially quoted ‘herding behaviour’ as the answer and provided examples on that. in order to understand the psychology of investors and identify the irrationalities on part of the investors. it was required that the respondents be probed to get answers different from the past researches and specifically in context of Indian markets.
The semi-structured interview is one of the most frequently used qualitative methods. They provide an opportunity to probe answers and the interviewees can be asked to explain.
as the aim is to capture as much as possible the subject’s thinking about a particular topic.
Thus. during the interview stage. In subsequent interviews. every interview can be different from the other. Consequently.Chapter 3: Methodology to pursue an idea in more detail. the author later investigated on the discipline aspect of investment and found some very interesting results and answers. discussed in the findings and analysis section on page 96. The respondents were informed before the interview that the question sheet is just an outline of the topics to be covered. For example. In fact. some new points were discovered. interviewer can raise new questions during the interview.
Nevertheless. Many questions evolved during the course of the interview and hence the choice of semi-structured open-ended interview proved quite beneficial. semi-structured interviews were used for collecting data as it was the best option to get the answers to the research questions and meet the objectives of this research. which were later asked to the other respondents to elaborate and express their view on.
The interviews were based on a series of open questions. in the second interview. which were used as a pointer for a wide-ranging discussion on –
. at the end. the respondent mentioned that ‘discipline is very important when making investment decisions and most of the investors lose money because they are not disciplined’ which was a new and interesting point. And they certainly proved to be a very useful strategy for collecting data.
In this dissertation.
Refer to Appendix 5 for interview questionnaire. Your time constrains prevent you from surveying the entire population. the behaviour of various market participants.Chapter 3: Methodology the efficiency level of Indian stock market. Sampling also saves time.. what irrationalities are investors prone to that affect their performance.
. There were time constraints as well as budget constraints for the researcher. Sampling (Saunders et al. 2000). 2003) is a valid alternative when:
It would be impracticable for you to survey the entire population Your budget constrains prevent you from surveying the entire population.2. sampling is valid for most of the above mentioned reasons. which was an important consideration for this dissertation. and how can investors identify good investment opportunities9. what investment strategy should be adopted by investors.5. The purposive sampling technique has been used due to the fact that this sampling technique allows the researcher to use their personal judgment to select cases that best enables the researcher to answer the research questions and meet the objectives (Neuman.
For some research questions it is possible to survey an entire population if it is of a manageable size. whether I I’s are able to beat the market consistently.
.3 Research Participants and Procedures
Eight interviews were conducted from different analysts and investors.5. Telephonic interview was conducted because the interviewee preferred a telephonic conversation to a face-toface interview.Experience in Indian stock markets and their knowledge of the research subject.2. The Interviewees were selected on the basis of following criteria:
. 2 interviews in Indore on 11th November 2006 and 1 telephonic interview with an interviewee in Bangalore (all in India).
.Chapter 3: Methodology
3. 5 of them in Mumbai on 09th and 10th November 2006 at the offices of respective interviewees. . Moreover.
3. it was also not possible for the researcher to go to Bangalore for just one interview.5. .Diversity of background and job situations. the size of the fund they manage (in case of institutional investors).What companies are they associated with.2. .2 Research setting
The interviews were held in eight different sessions individually with each interviewee. Collecting data from fewer subjects means that the information can be more detailed (Saunders et al.Their association with the stock market. The seven interviews were conducted at the respective offices of the interviewees because they preferred the location for their convenience.What sort of portfolio they manage – active or passive. . ranging from institutional to individual investors in Indian stock markets. 2003).
Chapter 3: Methodology All the participants had excellent experience of Indian capital markets and were well acquainted with the concept of market efficiency, passive and active investment strategies and behavioural finance, which made the interview-process an enriching experience. In order to get insight on the subject from different perspectives, it was made sure that the participants/sample selected was diversified. Therefore, the sample included participants from mutual fund companies, stock broking companies and other institutional and individual investors. Participants included fund managers managing funds between Rs. 600 crores- Rs. 10,000 crores10 of both domestic and foreign investors. The sample also included both the proponents of active investment strategy and passive investment strategy.
Table 3 summarises the names and profiles of the interviewees11:
TABLE 3 Interviewee
Institutional Investors Hudson Fairfax Group (HFG) is a US based investment firm focused on sponsoring and promoting India-related investments. Mr. Ravi has 14 years of experience in the Indian capital markets and has a broad and successful background in Indian equities, including value and growth investing in both large and mid capitalization stocks. Benchmark is the only asset management company in India that purely invests through indexing. Mr. Jain has 8 years experience in Indian capital markets.
Mr. Ravi Gopalakrishnan
Portfolio Advisor to Hudson Fairfax Group (HFG)
Mr. Vishal Jain
Vice President, Investments and Fund Manager to Benchmark Asset Management Company
Approximately £71million-£1billion Refer Appendix 3 for detailed profiles of the interviewees
Chapter 3: Methodology
Managing Director of Atlantis Investment Advisors India Ltd Mr. Singh is also the Portfolio Adviser to the Atlantis India Opportunities Fund. Atlantis is a leading asset manager, specializing in Asian equities. Mr Singh holds a distinguished reputation in the industry and has more than 15 years experience of Indian capital markets. Mr. Singhal is also associated with the Indian capital markets and is involved in the investment arena.12 Mr. Sambre is a Chartered Accountant and offers investment advice to the private client group.
Mr. B. P. Singh
Mr. Rajesh Singhal
Anonymous Product Analyst and Assistant Vice President of Global Private Client division of DSP Merrill Lynch.
Mr. Vinit Sambre
Mr. Ashok Lunawat
Research Head of Arihant Capital Markets Ltd.
Mr. Lunawat is the Research Head of Arihant Capital Markets Ltd, which is a leading stock broking firm in India. A Chartered Accountant by profession, he is known for his analytical skills and holds 10 years of experience in Indian capital Markets research.
Individual Investors Member of Bombay Stock Exchange Mr. Ramesh Damani is a well known name among investors in India. A proponent of value investing, Mr. Damani has been tracking the markets for many years now and holds a distinguished investing record. Mr. Ranjeet Hingorani is also a value investor, and has a tremendous investing experience. He is a believer of Philip Fisher and Benjamin Graham’s theory on investing.
Mr. Ramesh Damani
Mr. Ranjeet Hingorani
Wealth Research Manager
The names of the interviewees are coded (some respondent’s details are anonymous) and the codes are listed in Table 4.
The company name and profile of the interviewee is anonymous as requested by him.
Chapter 3: Methodology TABLE 4 Keyword Mr Ramesh Damani Mr. Ranjeet Hingorani Mr. Vishal Jain Interviewee 4 Interviewee 5 Interviewee 6 Interviewee 7 Interviewee 8 Code RD RH VJ I4 (RS) I5 (RG) I6 (BP) I7 (AL) I8 (VS)
The interviewees were given a questionnaire before the interview to get to know if they understand the basic terminology and concepts used in the interview. A copy of the questionnaire is attached in Appendix 4. A sample of the questions was supplied in advance to all the interviewees but the discussion was open-ended and the questions were merely indicative of the areas to be covered. A copy of these questions is attached as Appendix 5 and the summary of the responses is presented in the ‘Findings and Analysis’ section on page 62. For complete interview transcription, please refer to Appendix 7.
Table 5 segregates the participants on the basis of different criterion.
I5. I6.Chapter 3: Methodology TABLE 5
Active Managers: 7 (RD. 14) Other Institutional Investors: 1 (I8)
Mutual Fund Manager: Managing fund of – Rs. RH.000 crores (~ £1bn): 1 Investing funds for . RH. 10. I7. I5. and notes written afterwards are likely to miss out some details (Britten. I7. This source of primary data was seen as essential in understanding the reasoning behind the investing behaviour. I8) Passive Managers: 1(VJ)
Mutual Fund Managers: 3 (VJ. I8) Telephonic: 1 (I4) Tape-recorded: 5 (RD. However. Writing notes at the time can interfere with the process of interviewing. which lasted for 20-minutes. 15. 600 crores (~ £71m): 1 Rs. I7. 3 out of 8 interviews were recorded through contemporaneous notes.Indian clients: 1 Foreign clients: 1 Both: 1
Stock Broking company participants: Small-medium sized company: 1 (I7) Large-sized company: 1 (I4)
Interviews: Face-to-face: 7 (RD. getting insight of various contradicting views on 57
The interview was recorded by the taking of contemporaneous notes and audiorecording depending on the interviewee’s preference. I5. due to the reluctance of some interviewees. RH. 1995).VJ. I4. Therefore audio-recording was preferred. I6) Recorded through notes: 3 (I4. 6000 crores (~£710m): 1 Rs. Each interview lasted on an average for 60minutes with the exception of the telephonic-interview. RH)
Stock Broking: 2 (17. VJ. I6. I6) Individual Investors: 2 (RD.
if so. how?. concepts or theories used in research. However. which is not possible through a questionnaire. the interviewee misunderstood the meaning of the term ‘passive investment strategy’ while answering. Thus. and other research questions. for example. using the semi-structured interviews as the tool for getting answers to the research question proved to be the right choice and all the characteristics of these interviews discussed above seemed to be applicable in this research as well. identifying what investment strategy (active or passive) should be pursued by the investors. the interviewer could identify the misunderstanding and clarified the meaning of the term in reference to this study.
The interviews conducted helped in getting below the surface of the topic being discussed. But also the few questions answered by the interviewee were not reliable as the question was not understood correctly because of the misunderstanding of the term. which proved beneficial and added value in the research process. Thus interviews also help in clarifying any misunderstanding on part of the interviewees in regards to the questions. despite explaining the concepts before the interview was conducted.Chapter 3: Methodology whether one can outperform the market or not and.
. and uncovering new areas or ideas that were not anticipated at the outset of the research.
During one of the interviews.
4 Data Analysis
Figure 3 outlines the Data Analysis process
Detailed Explanation of figure 3 Once the interviews were taken they were subsequently transcribed. which made the data analysis a complicated process and it also turned out to be a time-consuming activity.Chapter 3: Methodology
3. the interview transcripts produced a large volume of material.5.2.
Content analysis was used for analysing the data. It is defined as ‘a set of procedures for collecting and organizing non-structured information into a standardized format that allows one to make inferences about the characteristics and meaning of written 59
summarises the key observations arising from the interviews that have ramifications for the purposes for which the data was generated.). 1999).d. n. This process is called coding. The table.Chapter 3: Methodology and otherwise recorded material’ (Anonymous II. However. in an effort to be holistic and provide a richer understanding of what emerged from the interviews.
. the data was subdivided and categories were assigned to the data. even if the meaning is not implicit in the transcript of the interviews.
Once transcriptions were done.d. generated in results section. This technique is popular for analysing qualitative data.).
For analysis purposes a tabular format of the commentary made by the interviewee is also presented that provides answers to some of the research questions. the tabular format is adopted but the commentary is extended to cover all key commentary made rather than excerpts. defined as ‘the process of translating raw data into meaningful categories for the purpose of data-analysis’ (Anonymous I. The original recording of the interviews was revisited during coding of every interview to ensure that the true meanings of the participant’s responses are captured. This will maximise understanding and minimise misinterpretations. This technique formally proposed by Locke (2001) has been replicated in other studies (see for example Crossan and Bedrow. n. 2003. Noble and Mokwa.
2002). in the research the focus was on communication with the participants with a degree of dynamism. reasons have been discussed in the earlier section.5 Rationale for Interviews for research
Interviews with analysts and investors was considered appropriate given that there were a lot of issues to be considered. Thus the entire approach and methodology used seeks to provide a comprehensive paper.6 Conclusion
To conclude. these issues were complex and the logic of the answers needed to be questioned. enabling the author to “probe” answers (EasterbySmith et al. This reflects that there was a constant shifting with the changing phenomenon and context and this in turn brought about flexibility in research.2. whereas the questionnaire method would not have provided for follow up questioning or requests for elaboration. It allows the researcher to understand the meanings that people hold for their activities (Marshall.
. In addition. In sum. which was crucial for this research. 1999).
3. the nature of research also required data gathering through interviews.5..Chapter 3: Methodology
3. Interviews are also a useful way of attaining large amounts of data quickly. the methodology used in this paper has used a very flexible approach and adequate care was taken in selecting data sources. a further advantage of conducting interviews was that it enabled a series of open questions to be put.
2000. Lo and Mackinlay. Malkiel. 1970. 1982. Kendall.Chapter 4: Findings and Analysis of study
CHAPTER 4: FINDINGS AND ANALYSIS OF STUDY
4. several studies have demonstrated that markets are efficient in weak and semi-strong form and few of them showed that they are even strong form efficient. Blanchard and Watson.‘Are Indian markets as efficient as other developed markets like US and UK? Why?’. the findings to the first research question . In Indian markets also. 1999) and in fact argue that if markets would be efficient.
. 1973. 2003. In this chapter.
4.2 Findings to the Research Questions and Propositions
The notion that stocks reflect all the available information in the market is supported by many researchers and academicians (Fama. In Table 6 below. 1953). interviews were conducted to find the
answers to the research questions and to test the propositions of this study. However. no market would exist at all. The interpretations of the commentary and findings are clearly highlighted in the table. others assert that stock markets are not efficient (Brealey & Myers.1 Introduction As
explained in the methodology section. 1965. 1987. the results of the interviews will be described and will be concurrently assessed with regard to the relevant literature. is presented using the commentary made by the interviewees.
EMH is helpful in understanding markets and it can serve as a benchmark from where to start. Indian markets are getting to a more efficient level. we are having lots of western influences. Therefore. Markets of countries like UK and USA are saturated.”
I4: “India is a developing economy and for high growth markets like India. Indian markets are probably less efficient than other developed markets and that is because the equity cult has just now begun to take place. Had computers carried out the analysis. every now and then the returns of some sector suddenly grow at high rates and people who are able to identify them beforehand can outperform the market. who interpret it differently. In real world information is analysed by people. in India.Chapter 4: Findings and Analysis of study TABLE 6 How valid is the theory of efficient markets? Are Indian markets as efficient as other developed markets like US and UK?
Key Commentary made
RD: “My understanding is that while markets are roughly efficient but they are not perfectly efficient and investors can take advantage of this gap between perfectly efficient and roughly efficient markets in order to maximise their returns. the theory might have been true. Indian markets are
. fund flow is not predictable. But as India is liberalising. It’s an emerging market and in emerging markets typically the values are unknown. the growth rates of companies are stagnant.”
I6: “EMH assumes that two people think alike. The mere presence of brain in humans deviates markets from reaching an efficiency level because market comprises of people and people make the markets and each person interprets or views things differently. since mid-1990. It is good in theory but in practice it does not hold true. However. the financial sector has also been liberalised. EMH does not hold true. India is not as efficient as the developed markets because it is an emerging economy.
They have also gone through the dot. Market is a reflection of many people taking decision at the same time and they make those decisions on the basis of the information they hold. Indian markets were not efficient 4-5 years back because the information was not disseminated properly.”
RH: “I do not agree with the EMH. However complete efficiency is a utopian idea. They are not as efficient as the markets of developed economies. it is efficient over a longer period of time but in shorter term. efficient markets are only possible in an ideal world. information is disseminated as soon as it is available and the dissemination is also
. which differs from person to person and hence all these factors together makes the market inefficient. But today the regulations in the Indian markets have improved..Chapter 4: Findings and Analysis of study
not as efficient as the developed markets. So on the face of it you’ll find that the valuations are fair. in theory it holds true. market may not be efficient. yes. their psychology.”
I5: “Firstly about EMH. In fact. I think Indian markets will still take time to reach the level of developed markets like US or UK market. But in terms of practicality. Also there is no difference in the efficiency level of the stock markets in India and other developed markets because the people and their behaviour is the same and the greed exists everywhere. say 3-6 months over even a year sometimes. it takes time for the market to understand that information. and often times what happens is like there is not proper dissemination of information. but not in reality.”
VJ: “I agree with EMH to some extent.com boom and bust like India. etc. Reason being that there is always mismatch in expectations and this mismatch causes inefficiency in markets. However to some extent the markets are efficient because everyone has access to same information. their interpretation of the information. In my view. India is a volatile market.
there are more researchers.”
I8: “Indian markets are not efficient. in the sense that not all information is interpreted by computers. Now. Other reasons for the difference include Indian stock markets are not as well-researched as of developed economies. no market would have existed.”
Interpretations Indian markets. in fact I think if efficient markets theory would have been true. Reasons for market inefficiency are – mismatch of expectations. behavioural patterns.
The findings also indicate that as Indian markets are getting attention
. fund flows are not predictable. and much more technically qualified people than earlier. Indian markets would become more efficient. The research on the markets has improved manifolds. there is improper dissemination of information. information not always fathomed correctly and above all the way information is being interpreted. And over a period of time. The
theory of complete market efficiency is only possible in an ideal world.
There is clear indication of difference in the efficiency level of developed and Indian stock markets. Therefore the markets are much more efficient than they were few years back. in fact.Chapter 4: Findings and Analysis of study
higher leading to markets becoming more efficient. the Indian economy is growing exponentially and there are many high growth-rate companies that are not present in developed markets. it is a volatile market. people are involved in assessing the information and people holding different perceptions assess information differently. EMH is a reflection of an ideal world and ideal world does not exist. The main reason for this difference is that India is an emerging economy. no stock markets are completely efficient. analysts.
liberalisation is taking place in financial sector and markets are becoming well researched. it would take some time. Krishnaswami13 also agrees that ‘the Indian stock markets lack liquidity and many Indian companies are thinly traded in markets controlled by powerful local brokerages’ (Knowledge@Wharton. But they are not completely efficient.
. Markets cannot be completely efficient nor are they completely inefficient’. “I’d be a bum on the street with a tin cup if the markets were always efficient”. Findings also confirm that Indian stock markets are not as efficient as the other developed stock markets (like US or UK).
Mukund Krishnaswami is managing director of Krilacon Group. The results indicate that no stock market can be completely efficient or completely inefficient. an investment firm based in New York and Philadelphia.
The findings are in line with many studies that confirm that Indian stock markets are efficient in weak and sometimes semi-strong form.
The answer to the first research question in Table 6 and the findings of the study yield an apparently significant result to the first research proposition that says: ‘Complete market efficiency is a utopian idea. the efficiency level is gradually integrating with the developed markets. 2006). the regulations are becoming restrictive.Chapter 4: Findings and Analysis of study
from foreign markets. discussed in literature view. The first proposition is therefore correct in context of this study. As Warren Buffett once commented. But for this process to materialise fully.
The results from this study concur to this evidence. 2003). ‘information disseminates and there is immediate reaction but the final conclusion of that may sometimes take even years before the market understands what it holds’. In context of global stock markets (including India) Mr.
In the literature review it was indicated that several event studies have shown evidence of under-reaction in which the market response to new information appears to be too little or too late.
Table 7 further summarises the findings along with the response of the interviewees on information dissemination and its interpretation. Therefore.
. Damani quotes. This study confirms this statement. this discrepancy provides opportunity for smart investors to profit from and to understand that short-term price deviations should not cause panic or they should not make hasty decisions.Chapter 4: Findings and Analysis of study Empirical evidences have suggested that market participants do not comprehend and interpret information correctly that causes inefficiency in the market (for examples see Jegadeesh and Titman 1993. Rajgopal et al.
there are smart analysts sitting in the market who correct the price of the security if people misprice it. Market sometimes takes time to grasp the reality of particular information. Market prices the securities correctly in medium-short term. it takes time for people to understand the full implication of the information”
I4: “Market prices the securities in a longer period. because in short-term many factors causes deviations”
RH: “Information in the short-run and sometimes even in a longer period is not interpreted correctly. Markets price the securities correctly in the long-run. Understanding the value of particular information and its implication on a company is an art. that is what I would call as overreaction bias.”
. Inefficiencies would go away in a longer-term and there are no surprises in long-term which would deviate the market price from the intrinsic value. and not everybody can understand it atleast in the short-term. The market prices the security correctly only in the longer-run. sometimes the expectations of the market are so high that people actually misprice the securities. Even if the general public does not understand what lies behind. On the basis of just one piece of information people under-react or overreact and ignore the other factors that may be equally important in price determination.g.”
VJ: “I think information is interpreted correctly and its meaning immediately reflects in the prices. medium term or longterm?
Key Commentary made
RD: “Beauty is in the eyes of the beholder. For e.Chapter 4: Findings and Analysis of study TABLE 7 Is the information that is disseminated in the market interpreted correctly by the investors? Does the market price the securities correctly in short-term.
existence of both the buyers and sellers in the market prove that same information is interpreted differently and there is rational and irrational action on the basis of that information. there might be discrepancies in terms of pricing but in a long-run definitely markets price the securities correctly. For example. In short-term there is discrepancy in pricing but in longer run it is corrected because the information sort of populates down (people understand the information and what lies behind it). There may be other external or international factors (psychological) like if there is a war going on somewhere and their markets and other markets are not doing well.
I8: “There is a discrepancy. Short-term markets are driven by irrational investors. the information that is disseminated may not be comprehended in the same manner as the company wanted to show. people might expect companies and markets in India not to do well. Reason being that the information might not have been incorporated completely. For example. In short-term there might be fluctuations. It is just panic from investors or an opportunity for speculators to make profits by driving the market away from its fundamentals. there might be disbelief in terms of what is going on.Chapter 4: Findings and Analysis of study
I6: “Over longer-term markets prices the securities correctly”
I5: “Markets price the securities correctly in Medium-long term.”
. their efficiency. external events like a bombing in UK will result in crash of Indian markets despite the fact that such an event actually has not affected the Indian economy or its industries and companies. However. other factors also settle down”. In fact. Each individual will understand and henceforth react in a different manner. in a longer-term the true picture will show and prices will reach their intrinsic value. Markets price the securities in a longer-term.
Interpretations Generally believed that market participants take time to grasp the reality
of the information. External factors which actually do not have any effect on the companies may cause these deviations. Further research on the area is needed to find the validity of this argument in Indian markets. markets are sometimes driven by irrational investors who cause prices to deviate from their intrinsic values. Investors panic if information is not what they expected. away from their intrinsic value.Chapter 4: Findings and Analysis of study
I7: “In short-term prices often deviates from their intrinsic value. in the short-term. smart arbitrageurs exist who bring the securities to their correct prices. information that is disseminated in the market is not always interpreted correctly by the investors. VJ’s statement about the information dissemination varied from all the other respondents.
Answer to the first question broadly answers the second part. General consensus is that markets prices the securities correctly in the long-run. In sum. Its implication can be that it can provide opportunities for smart investors and analysts to profit from. On the other hand. In the short run. However over a long-run the true picture is identified and hence markets price the security correctly. expectations formed before the information is disseminated causes distortion of true picture.
. sometimes it takes a long time to understand the fullimplications of the information. All such factors lead the prices of stocks. Information may not be comprehended in the same manner as the information-provider wanted it to. He said that information is indeed interpreted correctly and even if some people do not fathom it correctly and misprice the stocks.
When the interviewees were asked. one bull and the other bear. but they will rarely be in balance. ‘does the market price the securities correctly in shortterm. as well as their overall feeling about the economy in general and the stock market in particular’.
The results from Table 7 also clearly substantiate the findings of Barman and Madhusoodan (1993) who found that stock returns do not exhibit efficiency in the shorter-to-medium-term though appear to be efficient over a longer run period. 1987) argued that investors tend to overreact to extreme price changes due to the human tendency to overweigh current information and underweigh prior data. upon other investors. which do not have much affect on the economy and stock markets. I7 says ‘people generally tend to forget the past and other factors that have an effect on the company and give so much weight to the current information that it leads the price deviation from its intrinsic value’. both political and business. The results from this study
. medium term or long-term’. When bulls predominate the market will go up. There is a tendency to over-react to some piece of information amongst the investors and under-react to others. In the short-term many macro-factors like war in some part of the world or a terrorist attack in another country. all of them answered that it does it in a long-run or medium-to-long run and that markets are not efficient in the shorter term. and when bears predominate the market will go down. also affect the prices of the securities. DeBondt and Thaler (1985. The ratio of these two sets of people will vary according to their interpretation of various news items.Chapter 4: Findings and Analysis of study Results from Table 7 confirm the argument of Brian (1994) – ‘At any time there will be two sorts of operators in the stock market.
Chapter 4: Findings and Analysis of study concur DeBondt and Thaler findings, and this provides another reason for why markets are not efficient in short-term.
Benjamin Graham (1965) was therefore correct in suggesting that ‘While the stock market in the short run may be a voting mechanism, in the long run it is a weighing mechanism. True value will win out in the end’.
The results clearly indicate that in the short term several factors causes prices to deviate from their intrinsic value, however in a longer period all the shocks and surprises vanish and the price of a security reflects its true value. These findings generate important results for proposition 2 of this research that says: ‘Stock markets price the securities correctly in long term. In other words, over a long-term the price of a company’s shares reflects its intrinsic value’. Proposition 2 has been tested and verified and the finding from this study shows that it is correct.
Table 8, below, seeks to provide an answer to the third research question.
TABLE 8 What investment strategy should be adopted by individual investors? Does their risk profile affect their choice of investment strategy?
Key Commentary made
RD: “I believe in active strategy for investment. Passive investment strategy is good for people who actually don’t have time to follow the
Chapter 4: Findings and Analysis of study
financial markets, don’t have time to think or read the Balance sheets, and meet and talk to the management of the companies. So it is a low cost way to take the advantage of the economic growth of a country, just buy the index and get market returns. And yes, the risk profile of an investor will also affect what investment strategy he wishes to adopt. A risk-averse person would prefer indexing, while someone who is less risk averse will go for active strategy”.
I4: “What investment opportunity should be adopted by investors actually depends on their risk profile. If you are a more risk-averse individual, you should go for passive investment strategy, while a riskneutral or less risk-averse person should go for active strategy. However, in a country like India, I think, they should go for active investment strategy because Indian stock markets are developing and in Indian markets abnormalities often occur which causes inefficiency and thus opportunities for active managers to profit from them.”
RH: “Individual investors who do not have expertise and understanding of analysing companies, markets and sectors can straight away go for indexing, because the expenses and cost to the investor is less and they will be much better off than many active investors. When market falls, active investors may lose much significant amount than passive investors. Risk profile of an investor may not necessarily affect his choice of investment strategy. A person who is risk averse, because he has made one correct decision in investing his risk taking capacity increases. He becomes intelligent and brave in his own eyes. And then he takes that additional risk that is disastrous. So risk profile for me is a relative term. When an investor is making money, for him risk becomes irrelevant and when he loses money he realises what he has done and becomes risk averse but then it is too late”.
Chapter 4: Findings and Analysis of study
I5: “Active will generate better returns. Even a passive investor, when sees his returns are lower than markets, will eventually divert to active because of the nature of Indian markets, they are very volatile.”
I8: “I think that individual investors should adopt an active investment strategy broadly, but if they want stable returns and are risk-averse they should adopt passive strategy. Moreover, since the investors do not have access to information and resources to analyse and understand that information as well as the fund managers do, they should invest in the market through professional investors, rather than doing it themselves.”
I7: “There is low risk in passive investing, but not necessarily true in volatile markets like India. I would recommend active strategy because that is what investment is all about.”
VJ: “I think it should be a combination of active as well as passive strategy. Simply because there are periods when active fund managers outperform the market and indexing doesn’t generate returns. And obviously the skill is there and that skill of active guys should be valued. However, because an active manager has outperformed the market this year doesn’t guarantee that he will be able to outperform in the coming time. I don’t want to take this risk. I might as well put my funds in an Index for 4-5 years and I believe in it because if our economy is going to grow, which it will, so obviously the large companies are going to benefit the most. I want to be invested in the best companies and that is reflected in the Index. I don’t want to put my money with some fund manager who might be there today but might not be there tomorrow, who is performing today but might not be performing tomorrow. I don’t want to make that call. Yes, definitely the risk profile of an investor makes a difference in his investment strategy. If the investor is risk-averse, he would probably
No one advised a pure passive investment strategy.
Malkiel (2005) argues that . the more one earns the more risk taking he becomes. some advice going through mutual fund channels only but through active managers.”
There are divergent opinions on what investment strategy should be adopted by individuals. then professionally managed investment funds should easily be able to outdistance a passive index fund’ and shows in his paper that professional investment managers. he is content even if he is just getting the market returns of say 20-25%. He would not want 30-40% return that may not be stable. the above statement and finding provided by Malkiel does not hold true. Two interesting perspective also arose. The results from this study show that passive (or index) funds are
. and abroad. A more risk-averse person would pursue a passive strategy and a less risk averse will follow active strategy.S. some suggest active strategy. First is that risk profile affects the choice of strategy but a passive strategy may be more risky in volatile markets like India and second is that risk is a relative term. do not outperform their index benchmarks and provides evidence that by and large market prices do seem to reflect all available information’. But surely if market prices were often irrational and if market returns were as predictable as some critics have claimed. both in the U. One interesting response was a combination of both active and passive.‘In recent years financial economists have increasingly questioned EMH. To the extent of Indian markets.Chapter 4: Findings and Analysis of study
prefer being with the index. Clear indication of risk profile affecting choice of investment strategy.
Another reason for the unpopularity of index funds in India is costs. All the mutual fund managers in this study have agreed to this that in India. ‘In India.Chapter 4: Findings and Analysis of study not very popular in India and in fact there are examples of active funds that have beaten the market consistently.
Thus the findings from this study contradict the assertion of many researchers who agree with efficient market theory’s implication that it is not possible to beat the market. Even other investors have confirmed this view. ‘there are not too many takers for such funds (passive) in India. This gives fund managers several investment opportunities to outperform the index. published in 2005. they are not as cost-effective as their US counterparts when it is compared to their actively
This evidence is provided by Personalfn (a investment advisory company in India) in their article Index funds: Too expensive. This is because unlike the United States (or UK).
. there are actively managed funds that comfortably outperform the index over longer time frames (over 3 years). there are ample opportunities for active managers to outperform the index and they have been consistently doing it. India is a developing economy and many stocks are still under-researched. So investors chasing performance still have a good reason to invest in active funds’14. As Dey (2006) points out. even though the asset management company in question may be backed by the mighty HDFC (a leading and renowned asset management company in India)’. Although index funds in India have a lower expense ratio vis-à-vis their actively managed peers.
Results also indicate that in the coming time.Chapter 4: Findings and Analysis of study managed counterparts from the same fund house (Personalfn.
Table 9 provides evidence on whether overvalued/undervalued stocks exist or not.
These findings provide an indication to the passive fund managers to develop their products in ways that will be attractive to customers. which results in undervaluation and sometimes overvaluation of the stocks. it is either underpriced or overpriced’16.
Refer Appendix 6 for the expense ratio of active and passive funds in India and in US. the costs associated with passive funds are not low enough in India to get investors interested.”
I4: “Yes overvalued and undervalued stocks do exist.
. The findings from this study also shows that there is a need for awareness of indexing strategy amongst individual investors. In fact it is corollary of the fact that markets are inefficient. as the markets will reach a more efficient level.
TABLE 9 Do overvalued and undervalued stocks exist?
Key Commentary made
RD: “Yes they exist and because they exist I am able to make money otherwise I would have been a poor guy. in India. passive strategy will gain popularity. Expectations differ in the market.”
Motilal Oswal when asked in an interview if the market is reasonable valued answered. 2005)15. I would have been out of the market. Thus. ‘The market is never reasonably valued.
This is a clear indication of existence of overvalued and undervalued stocks.
Motilal Oswal is the Chairman and Managing Director of Motilal Oswal Securities.Chapter 4: Findings and Analysis of study
I7: “Markets are often driven by greed and fear of the people. which is amongst the top 5 broking houses in India. Stockbrokers used to telephone their clients and convince them to come to the market atleast for a few hours. Nothing went wrong with the company. I have actually seen that the offices which used to be packed with traders and investors 2-3 years back had no one except the operators. But it was the fear and over-pessimism that was guiding them. Markets are like a pendulum which swing between the phase of overvaluation and undervaluation”. it was still selling its products.”
I5: “Yes overvalued and undervalued stocks exist all the time”
I8: “Yes. While 3 years back. definitely overvalued and undervalued stocks exist in the market. they are so scared of the market that it causes companies selling sometimes below their cash value. Being an analyst. This comment is taken from a Newspaper article by Bhagat (2006)
. people actually were paying up to say 50x the price to get the same company. as has been seen in 2000-2001 Internet bubble. which causes stock prices to move beyond their intrinsic value causing overvaluation of stocks. Similarly when people suffer losses because of the mistakes they commit of buying stocks in highly overpriced market without understanding fundamentals. generating profits and running its business. In 2002-2004. I found some very good companies during that phase whose stocks were selling in the markets at unbelievably low prices and no one wanted to buy them.
Half of them lose and half win. in Mumbai say 3000 people play tennis everyday. it is possible to beat the market consistently’. Difference in expectations. how to beat the market. Even Warren Buffett underperformed for the brief period of technology boom.
. i. ‘People say that since nobody can beat the market why should I try. But nevertheless. but the fact is it is not impossible either’.Chapter 4: Findings and Analysis of study
Common belief among participants that overvalued and undervalued stocks exist in the market. But then over a longer run.e. Let me give you an example. I6 comments: ‘not everyone can continue to outperform the benchmarks all the time. people who have that acumen can outperform others in Indian stock markets. They have to get back and get their credit’. Identifying undervalued and overvalued stocks can provide opportunities for investors to outperform the market. so that doesn’t mean that people who lose will give up trying. which is not possessed by everyone. I5 also commented ‘I am admitting that it is not easy to beat the market especially with the changing scenario of Indian stock markets as they are being wellresearched. over-optimism and over-pessimism and fear and greed amongst investors and the recent Internet Bubble confirm that overvalued and undervalued stocks exist. The how part.
Finding from Table 9 and verdicts of interviewees show that it is possible to outperform the market. It requires skill and investment acumen to identify these opportunities. RD remarked. So the question is not this. is discussed on page 94. especially in India.
These results verify proposition 3 that says: ‘It is possible to outperform the market on a consistent basis and skill plays an important role in such performance. distinct him/her from the average people and using this he/she can outperform the others. 8 and 9 and the subsequent discussion clearly demonstrate that it is indeed possible to outperform the market consistently but it requires distinct skill and investment acumen. Shiller (2001) also says that ‘Success in investing usually involves some acquired skills in understanding the particular category of investment and in the strategy of dealing with it’. VJ also commented on the presence of skill in Table 8 that implies that skill helps in selecting good investment opportunities. Thus the findings of this research confirm and verify the above proposition. The chances of consistently outperforming the market are low. ‘If we actually contain to stick to our basics then only we will be able to beat the market through our skill through our vision’.Chapter 4: Findings and Analysis of study I5 quoted: Skill is an important factor that distinguishes an outperformer from others’. Skill plays an important role’. I7 stated that. He further adds that ‘To outperform the market a good judgement is required and that is matter of skill.
. albeit possible’. I8 quoted: ‘your skills and ability to identify good opportunities are important in making investment-decisions’. RH also agreed that ‘vision and analytical skills’ of an individual that others do not have. which everyone does not possess.
The above discussion and results from Table 6. 7.
when they come to the stock market they look at price and not value”. bulk of the
investments that is done in the market is done with the mindset of
.Chapter 4: Findings and Analysis of study Table 10 provides results on whether the majority of markets participants in India are driven by short-term speculative motives or not? And also attempts to test the Research Proposition 4. Very few people in the Indian markets are there for a long-run. but then there are people who want to stick to their decisions and are not speculating. Speculators do exist. Nobody wants to wait for their returns. but rather in estimating the short-run price movements’.”
I5: “I think it is a fair comment and I don’t dispute that. He argues that investors are guided by shortrun speculative motives. They are not interested in assessing the present value of future dividends and holding an investment for a significant period.”
I6: “Keynes’ picture of the market is absolutely correct. Is this statement correct in context of Indian markets?
Key Commentary made
RD: “I think he is right. People don’t picture their stocks as investment.
People don’t want to invest money but play with the market. traders also exist who carry out speculation.
Table 10 ‘Keynes’ pictures the stock market as a ‘casino’ guided by ‘animal spirit’. But like I said. So I agree that stock markets act like a casino where people are looking for short-term fluctuations and not long-term value and it is there for their detriment. Globally investors behave the same way. People do take a longer term view.
I4: “I don’t think it is completely true.
bank clerks. Most of the people in India invest for the short-term.”
I7: “Keynes made a fairly correct statement.
When the interviewees were asked to present their opinion on Keynes’ view of the stock market (see Table 10) all of them supported Keynes’ picture of stock market. though sometimes even they are driven by this animal spirit. In fact even my cook wanted me to recommend him stocks to put his money in. It is actually like a casino for them. very few people actually are long-term investors. prices of securities often deviate from their intrinsic
. Results from Table 10 verify the proposition 4 that states: ‘Most of the people putting-in money in the stock markets in India are guided by the short-term speculative motives. In fact. However. this problem is more severe in Indian markets. actual investors do exist. I think his explanation is correct and this happens in the market.”
I8: “In regards to Keynes’ picture of the market. credit managers investing in the stock market. Therefore. People actually think it is a casino where cheap money can be made but believe me there is no cheap money in this world. In fact even they are sometimes driven by the markets and indulge in speculation. And believe me they don’t understand a bit about the company they are putting their money in. everyone is here to make cheap money.Chapter 4: Findings and Analysis of study
making short term profits and that is why people don’t make money. Especially when the markets are on a bull run. software professionals. you will find housewives. doctors. But is this not what markets are for?”
Interpretations General consensus that most of the market participants are driven by
short-term speculative motives in the Indian stock markets.
Graham and Dodd. But people speculate and get in for adventure. Operations not meeting these requirements are speculative’ (Graham.
TABLE 11 Is Behavioral Finance (BF) important in making investment decisions? What irrational behaviour or emotional biases investors capitulate to. findings also indicate that long-term investors do exist who pass the definition of investors provided by Graham that says. Though such investors are very rare in the market and even they sometimes are sometimes susceptible to speculation. It is a fuzzy logic.
Table 11 generates the results on behavioural finance and irrational behaviour of the investors. but that is not the purpose of the market. upon thorough analysis.
RD gives a very interesting statement.Chapter 4: Findings and Analysis of study value’. in India. However. Without using their judgment
. ‘An investment operation is one which. ‘Stock markets are vehicle of producing only long-term wealth. You might be using it for different purposes and that is why you end up with bad returns and hard luck stories’. that affects their investment decisions and also market prices and returns?
Key Commentary made
VJ: “I think people have run out of ideas to beat the market and that is why things like BF are coming up. 1934). 2003. There is a tip-behaviour in India. promises safety of principal and a satisfactory return and people indulging in the investment operation are investors.
“Examples . ‘I should not be left-out’ attitude.
People don’t have time to analyse and get the information on the stock. And mind you ‘losing an opportunity hurts you more than having actually lost money’. Suddenly when you see something doing well. no one looks at it as investment. But in stock market the reverse happens.”
I5: “It is fairly important because a lot of time what happens is that there generally is consensus in the market and the consensus normally is wrong”. everyone wants to pile on it. Everyone in the market wants to make quick money. Now that is irrational behaviour. Then over-speculation.Chapter 4: Findings and Analysis of study
and research people invest on the basis of tips from the market. Greed. All this is irrational behaviour. you will buy more shirts because it is cheaper.
RD: “I think understanding
behaviour is important in
understanding markets and in making investment decisions. when the market goes down people run away instead of buying more they buy less. because they have their own work and business to manage. If you go to a store in sale and two shirts are selling for the price of one. so they just buy whatever is recommended to them. At the bottom of the market when they should be buying they are too scared to buy while in bull markets people will pay any price to get stocks of the company that are hot/popular. While when prices go up all of them want to buy shares. chasing stocks with no fundamentals at all just because someone on the street or your stock-broker has recommended you. Greed drives people.There is herd mentality on the streets. The attractiveness of the stock market is so overbearing that they can’t afford to miss anything like that.
One of the examples is herding behaviour. Since everyone is investing in the market and making money then why should I be left-out attitude exists.” I8: “BF is indeed very important in making investment decisions. Investors get optimistic when the market goes up. It is very helpful. Conversely. and know that they may be unable to control themselves in the future.”
RH: “BF is very important while making investment decisions.
I4: “Yes BF is actually very important and understanding behaviour can actually help us in not making the errors people generally commit in the market”. investors become extremely pessimistic amid downturns. Putting-in
money on tips. assuming it will continue to do so.
Interpretations Generally believed that behavioural finance is very important in making
.Chapter 4: Findings and Analysis of study
I7: “BF provides a platform to learn from people’s mistakes. herding without understanding why they are getting into a particular sector and without understanding why they are buying stock of so and so company. overconfidence. greed and getting emotionally attached to the shares are other examples of irrational behaviour seen in Indian markets.
People show problems of self-control. Even rational investors and professional managers follow the crowd. to modify and improve their overall investment strategies and actually profit from identifying these mistakes. There is a tip-behaviour in the market. because no one wants to do the hard-work and still want to make money”.
Most of the respondents agree that understanding people’s behaviour and learning from their mistakes can actually assist investors in their investment decisions and help them in improving returns from their investments. However. lack of self-control and emotional attachment to the shares invested in. 2006) and supports Mayer’s statement. overconfidence. over-speculation. one of the respondents comments that ‘The explanation provided by the behavioural finance
. greed. The irrational behaviour of Indian investors outlined include herding.
The findings of this research agree with the statement that ‘Behavioural finance essentially says that people are not the rational participants EMH makes them out to be. To sum up the comments. The explanations provided by behavioural finance theory and the involvement of psychological factors in stock markets cannot be ignored. one respondent presented a contrarian view that it is a fuzzy logic and can cause trouble if decisions are based on it. behavioural finance is actually important and can provide a means for understanding what errors should not be perpetrated. buying when markets are up and running away when markets are down without understanding the logic.
In explaining the importance of behavioural finance Mayer (2001) argues that ‘Many psychological biases are so persistent in so many individuals that it seems difficult that anyone could deny their existence’. The study shows that market participants can and do act irrationally’ (Anonymous I. However.Chapter 4: Findings and Analysis of study
investment decisions. investing on tips available in market without evaluating it.
. Behavioural finance is the study of how emotions and cognitive errors can cause disasters in our financial affairs. Parag Parikh17 agrees that behavioural finance is very important in making investment decisions and with its use once can get good returns from the market – ‘After an extensive study of the literature on behavioural finance. whether it works in different scenario. In stock markets.
Mr Parag Parikh has studied behavioural finance at Harvard University and is the Chairman of Parag Parikh Financial Advisory Financial Services. 2004). Frequently emotions prompt us to make decisions that may not be in our rational financial interest. Even if you try to understand people all the time.
Mr. jump in late and buy stocks that have peaked in a rally just before the price declines. Yet. take desperate risks and gamble wildly when our stocks descend’ (in Lohande. 2004).Chapter 4: Findings and Analysis of study theory is correct and one should try to avoid the general errors’ but further argues that ‘I might invest according to behavioural patterns and some day it might bomb on my face. you are not always be able to outperform & outsmart them’. India has been applying the concept of behavioural finance while investing in the stock market. behavioural finance can help explain situations such as why we hold on to stocks that are crashing. I believe that its perfect application could make you a successful investor making fewer mistakes’ (in Verma. whether it is stable. ridiculously overvalue stocks. we are not rational beings. He further adds. ‘Simply put. I don’t know to what extent it would work. we are human beings. standard economic theory starts with a flawed basic premise that the investor is a rational being who will always act to maximise his financial gain.
This is supported by a massive investment in research. money managers. fund managers use their expertise and spend a lot of time analyzing a stock.
4. In India. only a handful of the IIs in India are actually able to beat the market consistently. trading infrastructure. the tests and results confirm that ‘Behavioural finance plays a vital role in understanding investor behaviour and making investment decisions’. There are mixed views on whether behavioural finance theory can help the investors in improving their returns and outperforming the market. investors can improve their returns in the market’ – does not generate consistent result. communications and so forth.‘With the use of explanations on investor behaviour propounded by BF theory.1 Why are IIs not able to beat the market
Billions of dollars worth stocks are traded on Indian stock exchange18 every day.
The results indicate that pressure from investors to give quick returns is the main reason why Mutual Fund Managers (henceforth FMs) and other IIs underperform. its industry and peer group to provide earnings and valuation estimates. The results and findings have generated reasons for this underperformance discussed below. But despite all this. as discussed earlier. the opportunities for active managers to outperform the market are greater than the developed markets.Chapter 4: Findings and Analysis of study In regards to the proposition 5. But the second part of the proposition that states . Mumbai (BSE) website
. All the interviewees agree that the fund managers have to report daily Net Asset Value
National Stock Exchange of India (NSE) and The Stock Exchange.2. Analysts.
which causes pressure on them and they start investing in the momentum stocks or the so-called current hot sectors in the market. a pressure is created on FMs to show performance everyday. Now due to this.sebi. Figure 4 gives a model of how the pressure is created on FMs. otherwise their clients shift to other funds.com)
. This pressure causes them to invest in momentum stocks.Chapter 4: Findings and Analysis of study (NAV)19 of their funds. which may even be
The performance of a particular scheme of a mutual fund is denoted by Net Asset Value (NAV) (source: www.
There are various funds available in the market and investors (clients) have many options to choose from. In the mutual fund industry in India. FMs have to report the NAV of their fund everyday as seen in Figure 4.
Suppose if we buy a house. we don’t check its value everyday although it may go up and down. however it is more prominent in emerging economies like India and less in developed economies. But they will have to take long-term perspective. launch their marketing campaigns. RD comments. Now if you force yourself to look at NAV everyday. People investing money in stock markets want to generate short-term profits. And I think this phenomenon is worldwide. If in the short run a fund does not perform. ‘There is a funny business going on in the mutual fund industry. It’s a very NAV driven industry and everyday the NAV is reported. People will have to take a long-term perspective in stock markets’. people
Dalal Street in India is analogous to Wall Street of USA
. in a wrong fashion. Now stock market is not conducive to printing a NAV everyday. you are going to end up not making any money because you then tend to go with the stocks that are moving up. They create new products. ‘Investors create pressure on fund managers and that is why they get into momentum stocks’. I6 explains. investors withdraw their money from it and invest in other funds and so FMs are also pressurized to select sectors and stocks which will generate short-term returns and so they fail to show their performance. Businesses perform and keep doing their work irrespective of what is happening on the Dalal Street20. you have to look at this over a period of time not everyday. You don’t need to check your investment’s value everyday. and enter new markets and all this has nothing to do with the stock exchange’. I6 also remarks ‘The manner in which the money is invested is wrong.Chapter 4: Findings and Analysis of study against their own judgement. in my opinion. He further adds that. So the whole Mutual Fund business is structured. ‘If the fund manager is not investing in the ‘hot’ sector because his logic and judgement says not to and he underperforms compared to others.
Thus results show that FMs are more short-sighted under stronger pressures from their customers concerned with short-term performance. so the compounded return of the person who engages in one time buy/sell is much higher than who actively buys and sells’. every time they buy/sell they have to pay the brokerage. reasons that could be justified to a committee. In fact one of the respondents even commented that ‘I often trade too much because my clients demand short-term performance’. Their obeisance to conventional wisdom hampers their investment ability. That FM might then think that my business is suffering. using one’s own judgment can actually help investors to outperform others as has been
. So let me also participate in the sector. they have to pay extra for difference between bid-ask price. Moreover the frequent trading that they indulge in increases their expenses as RD mentioned. ‘people who frequently trade. But in making investment decisions. This frequent trading is also a result of sometimes pressure from the investors. But no one knows when this bubble will burst otherwise no one will invest in the bubble’. Over time all these costs add up to huge amount. if I don’t invest in the ‘hot’ sector I will be losing customers and I will be losing money. that they must have reasons for what they do. which are often intuitive.
Another reason for their underperformance can be attributed to the fact that generally IIs do not have the authority to make trades in accordance with their own best judgments.Chapter 4: Findings and Analysis of study will think ‘oh he has lost his touch’ and they withdraw money from his fund and invest in other funds. they have to pay transaction costs. When this bubble will burst I will walk out.
Findings also indicate that Institutional investors are not able to outperform the market also because: many schemes they put the money into are designed in a way that they are not supposed to beat the market. the thing is people should also have faith in his philosophy and judgement. i. This is the biggest problem in MF industry’. But it does not happen. IIs are not allowed to use their judgment and they therefore are not able to work to their best ability and not give performance. As I6 comments. Their motive is to generate safe returns. At the end of the day. VJ commented: ‘It is like the ‘chicken and the egg problem’.
The findings also show that IIs try to be jack of all trades. it is business.Chapter 4: Findings and Analysis of study discussed earlier.
. I might have a philosophy but I got to survive in the market’. And in the process they become average people and an average person will give you average returns. they try to be an expert in all the sectors and do not concentrate on areas that they understand. If his fund is underperforming his clients will shift to other FM and then he will not have the money to manage. So they need to focus on their strengths. I mean even if the FM has guts to sit in the market with his portfolio even when it is underperforming and still believe in his philosophy.e. ‘Investors put pressure on FMs to perform every quarter and the FM actually comes under pressure to retain the market share and they start looking at everything and basically become jack of all trades and master of none.
So it’s like flavour of the month like today. As I8 comments ‘If a well-known FM has identified something. This is a common mistake. the whole flurry of investors is into mid-caps stocks & funds’. hype is created and that sector becomes hot. In fact. in India. This would mean that he is just going to play around with 20-30% of the stocks in his portfolio to generate returns higher than the market-returns. The result is that they end up having similar portfolio. VJ also commented ‘If you look at the portfolio of active FMs. Everyone is having almost same portfolio. as VJ mentioned earlier. only a small chunk holds different stocks. stories are built. smart FMs exist and make good returns while others just pile on into that stock and most of them end up losing money’. Some firms are more heavily followed by the analysts than others.
The findings also show that most of the FMs and other IIs concentrate on mainly large-cap stocks. which again is a big call he is taking. 80% stocks they have in their portfolio are there in the Index.Chapter 4: Findings and Analysis of study Out-performance is not the motive of many schemes. ‘It is a business and at the end of the day I have to survive in the market. the others get into it. VJ further adds. pay salaries & bonuses.)
Herding behaviour amongst the IIs is another explanation to their underperformance. So eventually he is also going to give you index returns. I have to get the money. (This was highlighted by I8 and agreed by other interviewees. Simply
. most of the interviewees agreed that most of the portfolios of IIs are replication of Index. at this point in time. VJ also agrees that herding behaviour exists and that is why IIs are not able to beat the market. In fact.
and they do this because if they don’t get good returns they can say that they bought a good company.
Firstly. they pile on large-cap stocks. So indirectly he is also tracking the index’.2. Everyone is looking at the Nifty21. So their returns are ultimately market returns as they concentrate on Index stocks’. Thus.
. RH quoted ‘IIs are only comfortable with buying large cap stocks that is why they are over-researched. herding and concentrating on just segment of the market causes IIs to not generate returns higher than the market. which means only invest in companies that you can really
Nifty is an index of prices of a group of fifty stocks listed on the National Stock Exchange of India. in order to identify good investments it is important to start with one’s own ‘circle of competency’. so they have to hold the Nifty stocks also. If he is completely off the Nifty and his selection goes wrong he would be in trouble and he would not want to take that risk.Chapter 4: Findings and Analysis of study because the psyche is that he also cannot deviate much from the index because of the risk that he might underperform.2 How can investors identify good investment opportunities
The findings provide very interesting and valuable advice on how to identify good investment opportunities and what errors not to commit to improve the performance in the stock market. So rather than venturing into something that is unknown or less popular.
in 2000 he made a statement that ‘I don’t understand IT industry and therefore I don’t invest in it’. For a brief period his performance was down as compared to other active managers who invested in IT companies. markets. if you are a doctor. products. so I
Philip Fisher was a very successful stock investor. RD says. fund managers and other investors actually follow what Warren Buffett said. Very few money managers.g. you will be much better able to understand say this is the medicine that will be given to all the diabetic patients and has a huge potential. pick a pharmaceutical stock. whose business.
. You should not try to be ‘jack of all trades and master of none’. This idea was introduced by Philip Fisher22 and later championed by Warren Buffett (Hangstrom.Chapter 4: Findings and Analysis of study understand and can evaluate with confidence. You understand which the best medicine is and which company makes the best medicines amongst all. So you should build circle of competency in order to outperform the market. I6 commented: ‘Only focus on companies and stocks which you understand. for e. and you should look within that circle of competency. I don’t understand IT. he is an activist. You should be focused to the area and sectors you have understanding and knowledge about’. ‘The market specialises in 6000 stocks. But his performance again soared and the other managers actually lost tremendous amount of money. 1997). So the odds of beating the market improve dramatically because you are already within the industry. and management you can understand. one has to be focused on his basics and only concentrate on what he understands rather than getting driven or tempted by others.. and you can narrow it down to 5060 stocks that you understand and pick from them. So. An example for this can be given of Warren Buffett. In those brief periods of excess. best known as the author of Common Stocks and Uncommon Profits.
If the prices go up it is good and if it goes down it is bad. not only in terms of price but also in terms of understanding valuations.
. resisting the temptation of generating highreturns in short-term. And you need to have a disciplined approach of investing. All the interviewees stressed the importance of being disciplined in the market and also taking all investment decision with a disciplined approach. which is an important cause of all the FMs to underperform. People base their decisions on price and even professionals make that mistake.
One of the most important aspects highlighted by all the respondents was that getting good returns from the market would require a disciplined approach. I will only invest my money in what I understand. you will do better than the others’. I6 quoted: ‘Discipline has an important part in making investment decisions. They should only be venturing into industries and stocks which they understand’. they don’t understand valuations of a company’.Chapter 4: Findings and Analysis of study won’t invest in it. not to be driven by markets and sustaining from the short-term luring opportunities. because if you continue to put your money in what you know better. Very simple. I8 commented: ‘It is the ability that will always keep you ahead of the market. Not following the herd mentality – ‘Just because everyone is doing it I should also follow the herd’.e. you should not get carried away by the market. RD commented: ‘Discipline is extremely important. This discipline means not getting carried away by the market. i. You have to know your limitations and work on those limitations’. You have to be disciplined while making investment in the stock market.
Otherwise what is the point in identifying something which everyone has got into.
Another point highlighted is to time the market correctly. But having selected a particular company.Chapter 4: Findings and Analysis of study Strong fundamental research is important to evaluate an investment. But in my view. you should go back and look at the charts and you can check if there is volume happening in that stock. it is difficult but you got to get it right. disciplined investment approach is required. You can’t go and select stocks on the basis of technical analysis. it is important to identify the right time to buy the stock and also to sell the stock.
Three of the interviewees remarked that their experience says technical analysis can sometimes help in identifying the entry and exit time in the market. ability to identify excesses is also needed both when the markets are up and down. I5 commented: ‘Timing is extremely important in making entry to and exit from the market. The idea is not only to get the sector right. You got to get in early and be at the lead rather than a laggard because then you will only make index returns and not extraordinary returns. I5 commented: ‘From stock entry and exit point of view technical analysis is important. what are the range in which you
. is there some accumulation going on and such factors. It does help you in selecting your entry and exit points. This would come with experience and also with understanding the valuations of the security. in other words when making purchase or sale decisions in the stock market. Many people say that we don’t time the market it’s not possible to time the market. but to get it at the right time because it is not easy to determine the turnaround’.
i. It has been seen that stocks follow a particular pattern. technical analysis. And once you have identified that you want to invest in X company. technicals. It is. important to understand fundamentals. you are investing in a business not in the stock market.e.
VJ remarked: ‘Fundamental also works at the end of the day you have to look at numbers. capability of management. It is also important to understand that when you are making an investment. behavioural finance and your own judgment to identify good opportunity and evaluate it’. I don’t think one thing works all the time. if it still holds or not. behavioural patterns and other important factors when making investment decisions and also while identifying investment opportunities. inputs from fundamental analysis. So it is a good guiding tool but not from stock selection perspective’. So you can go back and check your fundamentals. Similarly in order to time the market you also might need technical analysis. I8 also pointed out that: ‘Technical analysis is a useful tool and can aid to time your entry and exit from the market. you can decide when should you buy stock of X company and when should you sell it off’. such factors should be taken into account while selecting stocks for investment’. RH commented: ‘Nature of the business. quality of the management. then with the help of technical analysis. you are buying a business. So you need inputs from everything. So you got to take inputs from everything.Chapter 4: Findings and Analysis of study can typically buy and if breaks a particular level then you need to be a little careful.
. therefore. Don’t base your decisions on just one thing. You might even need behavioural finance. and use those and the make your decisions.
You have to get into the nittygritty of the balance sheet of past few years. understand its competitive position in the market. assert that stock prices respond quickly to new information. what will future hold for this company. stock-splits or changes in firms’ dividend policies. RH remarks: ‘You will have to read a lot. sectors and other macro scenario that will help in selecting sectors and companies. find out companies which have consistently made profits and will be able to do so by looking how their management is. The market appears to anticipate the
. go through annual reports.3 Findings in context with Literature
Malkiel (2005) argues that markets are indeed efficient and provides evidence that by and large market prices do seem to reflect all the available information.Chapter 4: Findings and Analysis of study A lot of reading is required to get the information and knowledge about the companies. how good the product or service it is selling is. There is no short-cut in life and you have to be patient to be able to consistently beat the market. And then finally you have to make the judgement whether the company is good or not and its product will remain in the market in the coming 10 years. Fama et al (1969). You need to envisage whether this business is going to be there in the next 10 years. how good its research and development department is. and subsequently display no apparent strong trends following major events such as mergers. finding out what are their plans for the next 10 years. From these aspects you have to refine your research and select stocks of good companies.
4. You can create wealth only through taking a long-term perspective’. understand the company and the sector it is in.
Ippolito (1993. the results of this study appear to contradict this allegation.Chapter 4: Findings and Analysis of study information. 7. or information that is complex or requires a specialist's knowledge to comprehend.42) and Brealey & Myers (2000. both in India and other stock markets. p. 8 and 9 and the subsequent discussion clearly demonstrate that it is indeed possible to outperform the market and that too consistently. This result is supported by Stout (2003) who asserts that ‘Information that is easy to understand and that is trumpeted in the business media may be incorporated into market prices almost instantaneously. no security price can all the time reflect all the available information. Damodaran. 2002).
A review of the literature and an overwhelming body of empirical evidences shows that it is not possible to beat the market. They may not to for a temporary period. But information that is public but difficult to get hold of. but on an average they do outperform the market. Results from Table 6. This argument is supported by many researchers and scholars (Malkiel. especially not so after considering the expenses incurred on the research and analysis. 2005. p. There have been instances of funds and even individual investors who have been consistently beating the market on an average. Security prices in Indian markets do not always reflect all the available information. However. However. 361) also note that some recent studies have found
. 2003. and most of the price adjustment is complete before the event is revealed to the market. may take weeks or months to be fully incorporated into prices’. In fact claims have been made that since markets consists of human and their emotions are associated with market movements. the results present a divergent view.
.Chapter 4: Findings and Analysis of study that mutual funds outperform market indexes enough to offset their research and trading expenses.
more knowledgeable and skilled investors can strive to outperform less-knowledgeable and less-skilled ones. ‘all of human unhappiness comes from one single thing: not knowing how to remain at rest in a room’. In Indian stock markets. Apart from skill and investment acumen.
. that have substantial impairments of efficiency. as Higgins (1999) puts it. This study examined the market participant’s view on the efficiency level of Indian stock markets and the behavioural patterns of investors in India. As Blaise Pascal puts it.1 Conclusion A lot of body of evidences have shown that stock markets are efficient and it is not
possible to beat the stock markets consistently both in India and other global stock markets.
The study shows that Indian stock markets are neither completely efficient nor completely inefficient. a disciplined approach in the market and self-control is also essential to be able to beat the market. Critics have however argued that markets are not completely efficient and there are examples of out-performance that cannot be ignored as mere chance. “rather than being an issue of black or white.Chapter 5: Conclusions and Limitations of the study
CHAPTER 5: CONCLUSIONS AND LIMITATIONS
5. market efficiency is more a matter of shades of grey”.
the study also gives insight on how to identify good investment opportunities in the market and what strategies should be followed by the investors. Consistent with the theory.
Finally. But its usefulness in improving market returns was questioned by one of the respondents but others consented to its usefulness. Insights derived from this study can help the investors improving their performance in the stock markets.Chapter 5: Conclusions and Limitations of the study Existence of overvalued and undervalued stocks is also found in the Indian stock markets along with presence of active funds that have consistently beaten the Indian stock market. However.
The study documents the reasons for the underperformance of the institutional investors. The empirical results indicate that pressure from clients to give short-term performance causes an increase in the expenses of the IIs and is also the reason why they are not able to outperform the markets. herding behaviour and emphasis on large-cap stocks are also the factors that contribute to their underperformance. the results show that behavioural finance is important and behavioural pattern of the market participants should be examined when making investment decisions. A review of the literature showed divergent opinions on the importance of behavioural finance in making investment decisions. A preliminary objective of the study was to find out the importance of behavioural finance and whether its application can help investors in India to improve their returns from the market.
they should be viewed in the context of the limitations discussed in the following section.2 Limitations of the study and future research
“Finality is death. Nothing is perfect. to test the reasons for . Perfection is finality. Also.’
. I4 suggested that ‘to find out the correct picture of ratio of speculators versus investors look at the statistics or delivery volumes in stock markets.
An observed limitation of this study is that the area of study is very subjective. for example.
5.Chapter 5: Conclusions and Limitations of the study
Although the results and findings of this dissertation are encouraging. to test the behavioural patterns of investors in stock market.why the Indian stock markets are inefficient. For example. There are lumps in it” (James Stephens)
Nothing is perfect in this world and although the results and findings of this dissertation are encouraging. they should be viewed in the context of the following limitations. It is therefore recommended for future researchers to find out the ways to test and investigate the findings generated in this research. It is difficult. or to test how investors can identify good investment opportunities. I think a data research and survey would be more appropriate to find the answer to this question and I am sure you can easily find this data.
which was actually speculation of the answer and may not be reliable.Chapter 5: Conclusions and Limitations of the study This study used Qualitative research technique that has its own disadvantages. This creates problems of reliability as it is difficult to categorize descriptions into codes and themes (Silverman. 2001). the word qualitative implies an emphasis on the processes and meanings that are not rigorously measured in terms of quantity. As a consequence. the respondents might have answered whatever they thought at that time but they might not have had the knowledge about the subject. There are chances of researcher getting lost in the line of exploration as she might have failed to see patterns or skewed the analysis in one direction or another. More formally. the interviewee answered ‘I don’t know much about the US and UK markets. Firstly. when the question ‘are Indian markets as efficient as other developed markets’ was asked. the researcher might have found it difficult to link the specific questions to larger theoretical constructs to illuminate the bigger picture. but I think that Indian markets are not as efficient as the developed markets’. Some of the interviewees didn’t know the answers to certain questions asked during the interview and speculated their response. there is a probability of elements of researcher bias found in this dissertation.
. which can be a question-mark on the validity of the data. Since the discussion was subjective.
Another limitation is the inaccuracy and unreliability of the comments of the interviewee as analysts try to defend themselves and present a rosy picture about the investment strategies they adopt. In one of the interviews.
However. Other Fund Managers who managed passive funds are sometimes also in-charge of active funds and identifying and accessing them had not been possible. 2000). Therefore. the reason for such bias in sample selection was that.
The reliability of the results cannot be taken as concrete outcome since only eight interviews were conducted. but often crucial. pauses and overlaps (Silverman. Moreover. answers may be biased and may not have presented the true/complete picture. only one of them was pursuer of passive investment strategy. in India there is only one asset management company that invests only through passive strategy.Chapter 5: Conclusions and Limitations of the study The researcher may misperceive what the researched wants to communicate. the information gathered may not be reliable. A small sample is therefore another projected limitation of this study. The possibilities like the respondent didn’t tell the truth or uncovered few facts or the absence of complete set of recorded data may create a question-mark on the reliability of this study. As a result. more analysts. rest others were all active managers. out of 8 people interviewed. investors and researchers from different companies and adopting different investment strategies (active and passive) to offset single informant’s bias as well bias arising due to concentration on only active managers. the reliability of the interpretation of transcripts may be weakened by a failure to record apparently trivial. Even when people’s activities are tape recorded and transcribed. Future research should consider multiple informants or multiple members of the research team at each business unit. as the study was to be completed during a specific time frame.
But as Leonard Cohen quoted: “There is a crack in everything. The use of quantitative research methods and techniques may well improve the validity of the findings and are essential to avoid purely empirical exercises. that's how the light gets in”
.Chapter 5: Conclusions and Limitations of the study In qualitative studies.
The study and results were based solely on interviews. one important way of verifying findings or establishing validity is to actually take transcripts or analysed results back to some of the interview participants. this approach for validating the answers could not be carried out.
Another limitation of the study was that interview results required lots of interpretation from the comments made as it was not possible to frame direct questions on the topic in hand. use of quantitative study would be helpful. and ask them if this is really what they meant. For example to examine whether IIs trade frequently and actually take short-term perspective in the market. However due to time constraints and reluctance of the interviewee for validating their answers. for future research it is recommended that the researcher validates the data collected in order to improve the validity of the research. Thus. moreover the limitations of taking an interview will also be present.
provide guidelines for investors on the investment techniques that should be adopted by them. identify the behavioural aspects of market participant’s that can be used to correct the mistakes investors commit in the market. but it can provide a platform for other researchers to find out the causes of inefficiency arising in the Indian stock markets.
. and how can they improve it. The outcome in the results and findings section can help them to identify the mistakes and irrationalities committed by them and the market. this research has made an attempt to uncover the above subject areas and can therefore help the investors (both individual and institutional) in their investment decisions.Chapter 5: Conclusions and Limitations of the study This research may have shortcomings. Moreover.
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http://www. 2006]. D.org/papers/w9277. (2001) Doing Qualitative Research: A Practical Handbook. R.nber. USA: Harvard Business School Press. Review of Austrian Economics. In Anonymous (2005) ‘Workshop in Behavioral Finance’ [Online]. (2000) Irratinal Exuberance.econ. Vol. (1997) ‘In Defense of Fundamental Analysis: A Critique of the Efficient Market Hypothesis’ [Online]. 9 . (2005) ‘Size Effect in Indian Stock Market: Some Empirical Evidence’.. 635-669. pp.
.yale. R. V. Shostak. National Bureau of Economic Research. R. Stout. pp. (2003) ‘The Mechanisms Of Market Inefficiency: An Introduction To The New Finance’. (2003) Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing. S. W. J.edu/P/cd/d13a/d1303. 2006]. J.
A.htm [Accessed on 2nd Sept. (1994) ‘Efficiency of the Indian Capital Market’ [Online].com/abstract=729224 [Accessed on 30th June 2006]. 2006] Zheng. Available from: http://marriottschool. Available from: http://www. MA Finance and Investment.edu/~ziyu/AEP. 2004. L. University of Nottingham. Vaidyanathan. Indian Journal of Finance and Research. Journal of Financial Transformation. K. and Gali. (2005) From Rationality to Bounded Rationality [Online]. 5 . (2004) ‘Behavioural Finance as an investment concept’. (2004) Inefficient Market and New Finance. A. 2006]. pp. Available from: http://www. S.hinduonnet. Forthcoming Available at SSRN:
[Accessed on 30th June 2006].uwm.in/~vaidya/Capital-Market-IJFR. Verma. (2003) ‘An investigation of market efficiency and volatility spill over : the case of the merging African equity markets’. R. April 27th. Vol.edu/emp/SRT/passive. K.iimb. Unpublished Dissertation.com/businessline/blbby/stories/2004042700200600. The Hindu Business Line [Online]. Tuesday. R.
.byu.pdf#search=%22who%20proposed%20emh%22 [Accessed on 2nd Sept. 35-38.html [Accessed on 30th June 2006].References Stout. (1999) [Online] The Inefficient Market Argument for Passive Investing. V. Thorley.ernet. Tamakloe. Available from:
LIST OF APPENDICES
LIST OF ANOMALIES IN EMH (pp. 140)
INTERVIEW TRANSCRIPTS (pp. 134)
PROPOSED INTERVIEW QUESTIONS (pp. 124)
PROFILES OF INTERVIEWEES (pp. 124)
PREDICTIONS OF EMH AND EMPIRICAL EVIDENCE (pp. 135)
COMPARISON OF EXPENSE RATIO OF ACTIVE FUNDS AND PASSIVE (OR INDEX) FUNDS (PP. 130)
QUESTIONNAIRE BEFORE THE INTERVIEW (pp.
2001). 1983) noted that firms with high price-to-earnings (P/E) ratios earn positive abnormal returns relative to the CAPM. 1999). Many subsequent papers have noted that positive abnormal returns seem to accrue to portfolios of stocks with high dividend yields (D/P) or to stocks with high book-to-market (B/M) values (Schwert. There is a large body of evidence documenting the fact that historically. An investor who held the low P/E ratio portfolio earned higher returns than an investor who held the entire sample of stocks. 1999).Appendices
Anomalies in EMH:
. Capaul. Rowley and Sharpe studied six countries from January 1981 through June 1992 and found that Value Stocks outperformed growth stocks on average in each country (Anonymous. Basu (1977. Fundamental Anomalies
Value Effect: Value investing is probably the most publicized anomaly and is frequently touted as the best strategy for investing. investors mistakenly overestimate the prospects of growth companies and underestimate value companies (Anonymous. He shows that stocks of companies with low P/E ratios earned a premium for investors during the period 1957-1971.
42 percent for the other months. 2001). 1983) (Russel and Torbey.
. 1999).48 percent as compared to only . 2002). 2002). its attention and number of analysts that follow the stock (Anonymous. Calendar Anomalies
January Effect: Stocks in general and small stocks in particular have historically generated abnormally high returns during the month of January.Appendices Small Firm Effect: Some studies have shown that small firms (capitalization or assets) tend to outperform. Banz (1981) published one of the earliest articles on the ‘small-firm effect’ which is also known as the ‘size-effect’. The effect has been found to be present in other countries as well (Gultekin and Gultekin. Rozeff and Kinney (1976) were the first to document evidence of higher mean returns in January as compared to other months. Using NYSE stocks for the period 19041974. they find that the average return for the month of January was 3. His analysis of the period 1936-1975 reveals that excess returns would have been earned by holding stocks of low capitalization companies. Others have argued that its not size that matters.
B. Later studies document the effect persists in more recent years: Bhardwaj and Brooks (1992) for 1977-1986 and Eleswarapu and Reinganum (1993) for 1961-1990. Supporting evidence is provided by Reinganum (1981) who reports that the risk adjusted annual return of small firms was greater than 20 percent (Russel and Torbey. Keim (1983) and Reinganum (1983) showed that much of the abnormal return to small firms occurs during the first two weeks in January (Schwert.
2002). large-cap stocks consistently show higher returns at the turn of the month (Anonymous. interest payments.).d.Appendices Turn of the month effect: Stocks consistently show higher returns on the last day and first four days of the month.S. Hensel and Ziemba (1996) presented the theory that the effect results from cash flows at the end of the month (salaries. French (1980) analyzes daily returns of stocks for the period 1953-1977 and finds that there is a tendency for returns to be negative on Mondays whereas they are positive on the other days of the week.
The Weekend effect or Monday Effect: Monday tends to be the worst day to be invested in stocks.
. He notes that these negative returns are "caused only by the weekend effect and not by a general closed-market effect". n. Average return on Mondays is very small. Several other studies confirmed this anomaly. Frank Russell Company examined returns of the S&P 500 over a 65 year period and found that U. Prices tend to rise on the last day in a week. etc. would be to buy stocks on Monday and sell them on Friday (Russel and Torbey. The Price of the smaller firms shows greater changes in the weekend effect (Sato et al. Hensel and Ziemba (1996) and Kunkel and Compton (1998) show how abnormal returns can be earned by exploiting this anomaly.). which would be profitable in this case. in contrast with that average return on Fridays (or Saturdays). Ziemba (1991) finds evidence of a turn of month effect for Japan when turn of month is defined as the last five and first two trading days of the month. 1999). A trading strategy.
2002). More recently. Other Anomalies
Intraday Effects: On all days without Monday.
Announcement Based Effects: Price changes tend to persist after initial announcements. Thaler (1992) also said a part of these phenomena can be explained by the structural and institutional reasons such as 1) the difference of duration when a market is closed and 2) the special duration related to a settling day. Saunders (1993) shows that the New York Stock Exchange index tends to be negative when it is cloudy. there are likely to be more in hiding (Anonymous. have been observer in experimental markets. 1999).Appendices
C. Stocks with positive surprises tend to drift upward. particularly on the last trade of the day. Haugen (1999) argues that the evidence implies that
. Returns are high near the end of the day. prices rise during first 45 minutes. The day-end price changes are greatest during last five minutes.
The Weather: Few would argue that sunshine puts people in a good mood. Some refer to the likelihood of positive earnings surprises to be followed by several more earnings surprises as the "cockroach" theory because when you find one. People in good moods make more optimistic choices and judgments. those with negative surprises tend to drift downward. Hirshleifer and Shumway (2001) analyze data for 26 countries from 1982-1997 and find that stock market returns are positively correlated with sunshine in almost all of the countries studied (Russel and Torbey.
They report positive (negative) estimated abnormal stock returns for portfolios that previously generated inferior (superior) stock price and earning performance (Russel and Torbey. 2002).
.Appendices investors initially underestimate firms showing strong performance and then overreact. DeBondt and Thaler (1985. 1987) present evidence that is consistent with stock prices overreacting to current changes in earnings.
(Source: Breechey et al. 2000)
A proponent of value investing. Ranjeet Hingorani – A Wealth Research Manager. Ramesh Damani is a well known name among investors in India. Mr. Ravi Gopalakrishnan – Mr. a US based investment firm focused on sponsoring and promoting India-related investments. Hingorani’s value investing has generated him good returns from the market over the years. Mr. Mr. Email: rsdamani@hotmail. Mr. He has 14 years of experience in the Indian capital markets.com
Mr. has tremendous investing experience and holds a distinguished investing record. Damani is also a frequent commentator on financial issues on CNBC and Star News. Ramesh Damani – A member of Bombay Stock Exchange. Email: hingo@sancharnet. Gopalakrishnan is Portfolio Advisor to Hudson Fairfax Group (HFG). Damani has been tracking the markets for many years now. An MBA from California State University. He provides exclusive non-discretionary investment advisory
. and has a tremendous investing experience. He is a believer of Philip Fisher and Benjamin Graham’s theory on investing. Mr.in
Mr. Ranjeet Hingorani is also a value investor.
Mr. Eight years of experience in market strategy and research for UBS and Unit Trust of India Email: rgopal@hudsonfairfax.Sc. Singh is the Managing Director of Atlantis Investment Advisors India Ltd and the Portfolio Adviser to the Atlantis India Opportunities Fund. the only asset management company that purely invests through indexing. Vishal Jain .com
B. Singh – Mr. Email: vishal@benchmarkfunds. where he was part of the Capital Market group. Gopalakrishnan has a broad and successful background in India equities.Appendices services to HFG.Mr. He was then involved in setting up India Index Services & Products Ltd (IISL). he was also involved in promoting indices for the use of higher applications like Index Funds. a joint venture of CRISIL and NSE At IISL. Futures and Options. Mr. His experience includes: Formerly Portfolio Manager at Principal PNB Asset Management Company and Sun F&C Asset Management. where he ran the Sun F&C Value Fund and the Resurgent India Fund. Jain is Vice President – Investments and Fund Manager to Benchmark Asset Management Company. (CRISIL). He was previously with the Credit Rating Information Services of India Ltd. India. including value and growth investing in both large and mid capitalization stocks. India's premier rating agency. in Statistics and a MBA and has 8 years experience in Indian capital markets. P. He holds a B.
Media and Biotechnology sectors. Singhal the Investment Advisor and Portfolio Manager of a distinguished company.
Mr. specialising in Asian equities. He was directly responsible for India strategy and the Pharmaceuticals.Appendices Atlantis is a leading asset manager. Ashok Lunawat . Email: bpsingh@atlantis-investment. Mr. Prior to this. A Chartered Accountant by profession. Rajesh Singhal – Mr. BP Singh was Director . Before joining SSKI.Equity Research at SSKI Securities. He is a Chartered Accountant and offers investment advice to the private client group.Mr. Lunawat is the Research Head of Arihant Capital Markets Ltd. Sambre is the Product Analyst and Assistant Vice President of Global Private Client division of DSP Merrill Lynch. Singh joined Atlantis from Deutsche Asset Management.Mr. he is known for his analytical skills and holds 10 years of experience in Indian capital Markets research. BP Singh was Head .com
Mr. a leading stock broking firm in India. He has been continuously searching for fundamental
. He was Fund Manager of the Deutsche Alpha Equity Fund and the Deutsche Investment Opportunities Fund.com
Mr. He earned his MBA from SP Jain Institute of Management & Research at Mumbai and Bachelor of Technology (Chemicals) from University Department of Chemical Technology (UDCT) at Mumbai. a premier brokerage house in India. Email: vinit_sambre@ml.Research at UBS Warburg. Vinit Sambre .
quality management and excellent business model and has provided with some very good investment advice over the years.Appendices stocks with low valuations.
FOR RESEARCH PURPOSES ONLY
Please answer the following:
Do you know what is Passive Investment Strategy (or Indexing)?
Do you know what Active Management Strategy is?
Do you what is does the term ‘efficient capital markets’ or ‘Efficient Market Hypothesis’ means?
Do you know what Behavioural Finance is?
(i) Do you agree with the EMH? (ii) To what extent do you think the theory holds true? (iii) Do you think that it is possible to “beat the market”? If yes then can you please explain how it is possible? (despite so many research confirming that except a very few people.Appendices
Proposed Interview Questions:
1. (iv) Empirical evidences prove that passive investment strategy are better and more beneficial than active investment strategies because as the markets reach efficiency the cost incurred (time and money) in discovering the strategies to outperform the index outweighs the benefits received from them. Is this true? (v) Do you think that Indian stock market is as efficient as the capital markets of other developed countries like US or UK? Why?
2. most of the analysts and investors have not been able to beat the market). “What investment strategy do you think investors should follow?
passive?” (considering the evidence that cost involved (both time and money) in
Many researchers have proven that nearly all mutual funds and other institutional investors fail to beat the market on a consistent basis and that they underperform the market. mid-cap. company and the industry for prospective investment.Which types of stock (large-cap. how society will change. That is to say that long-term investment involves making one’s own judgement about the future state of economy.Appendices pursuing an active management strategy outweighs the benefits and Money Managers are not able to beat the market)
Why? What factors do you think should be taken into account? Does the risk profile of an investor make a difference?
3. the costs incurred in their research and other expenses wipe-off the benefits.
. small-cap) do you think Institutional Investors concentrate on? Why is that?
4. Can you explain the reasons for this? Or provide evidence when a fund or a company has been able to outperform the market over a consistent basis? . there has to be a major input of judgment that is essentially personal and intellectual in origin. In most of the instances. when they actually are able to beat the market. Institutional Investors: . Reaching decisions about such issues cannot proceed from analytical models alone. ‘Investing for the long term means judging the distant future. judging how history will be made. how the world economy will change.
for example. with new tourists checking on the
. investors are subject to a fear that others know more or have more information. looks at each of the restaurants. when you identified a particular investment opportunity. It is 6:00 PM.Two restaurants face one another on the main street of a charming Alsatian village.Appendices Technical models. Both restaurants are empty. The scene repeats itself. How important is Behavioral Finance in making investment decisions? (i) Can you provide some examples of investor behaviour (irrationality per se – like herding behaviour. another tourist shows up.
5. sees how many patrons are already inside by looking through the stained glass windows . As a consequence. There is no menu outside.these are Alsatian winstube and chooses one of them. over-pessimism or over-optimism) that causes inefficiency in the market from the Indian stock market perspective? And it’s Cause and effects? (ii) Are the explanations provided by the theory of behavioural finance regarding the efficiency of markets and behaviour of investors realistic? Examples of some of the argument and investor behaviour asserted by Behavioralists: When a market is moving up or down. After a while. investors feel a strong impulse to do what others are doing. is a good description of herding . Here. from your own experience. and goes into one of them. long before it was ‘popular’ in market and also detail on that. financial statements and other analytical statements do not suffice in making investment decision’ Do you think this statement is correct? Are subjective issues important in evaluating investments? Can you further elaborate this point from your perspective and give an example. A tourist comes down the street.
Do you think that markets price the securities correctly: . all newcomers choose the same restaurant: they choose the more popular one irrespective of their own information (iii) Are they correct from the perspective of Indian stock market? Can you further provide some examples of Investor’s behaviour that may be categorized as ‘irrational’ or that causes the market to deviate from being efficient?
Keynes’ pictures the stock market as a ‘casino’ guided by ‘animal spirit’. What is your view about the Keyne’ philosophy and why?
6. Do you think that as soon as some information regarding a security is disseminated in the market.in short-term? . but rather in estimating the short-run price movements. They are not interested in assessing the present value of future dividends and holding an investment for a significant period. After a while.in long-term? Why?
7.Appendices popularity of each restaurant before entering one of them. it is reflected in the price? Do stock market participants fathom the information correctly and act rationally or there is a discrepancy?
. He argues that investors are guided by short-run speculative motives.in medium-term? .
8. and it is just a way of fooling investors?
9. Do you believe in the existence of overvalued and undervalued stocks as against the many researchers and investors who think that there is no such thing in the market. How do you think should investors identify good investment opportunities?
-----------------------------Thank you for your time and patience----------------------------
10% 0.90 2.00 1.02
(Source: Personalfn.50 1.18% 0. 2005)
Comparison of Expense ratio of active funds and passive (or index) funds:
Expense ratio of Funds in United States of America
Fund name FIDELITY SPARTAN 500 INDEX VANGUARD 500 INDEX FUND FIDELITY CAPITAL APPRECIATION VANGUARD GROWTH & INCOME
(Data sourced from fund house websites)
Management style Index Index Active Active
Benchmark index S&P 500 S&P 500 S&P 500 S&P 500
Expense ratio 0.42%
Expense ratio of Funds in India
Fund name FT INDIA INDEX NIFTY FT INDIA INDEX SENSEX HDFC INDEX FUND (NIFTY) HDFC INDEX (SENSEX) HDFC INDEX (SENSEX PLUS) FRANKLIN BLUECHIP HDFC EQUITY FUND Management style Index Index Index Index Index Active Active Benchmark index S&P Nifty BSE Sensex S&P Nifty BSE Sensex BSE Sensex BSE Sensex S&P CNX 500 Expense ratio 1.94% 0.00 1.50 1.
Do you think markets are efficient? What is your view on EMH in context of Indian markets? Do you believe in active investment strategy or passive investment strategy? “My understanding is that while markets are roughly efficient but they are not perfectly efficient and investors can take advantage of the gap between perfectly efficient and roughly efficient in order to maximise their returns. everyone wants to pile on to the most popular stocks. But for patient investors. So there will be opportunities for savvy investors to outperform the market because of such behaviour. for value investors. since mid-1990’s. Ramesh Damani 14 Mr. So yes there are stock picking opportunities for investors in India. Obviously it is not possible that they buy and immediately sell and get good returns. Ranjeet Hingorani I5 I6 I7 I8 Mr. But as this bull market will demonstrate to you that while the Index is up three times from bottom to top individual stocks are 15x or 20x. But as India is liberalising the financial sector has also been liberalised. stocks that are ‘hot’ are in conversation in parties. Investors in market swing between fear and greed. almost in every stock
. Indian markets are probably less efficient than other developed markets and that is because the equity cult has just now begun to take place. which clearly is not possible in an efficient market. Vishal Jain
141 149 152 158 167 172 174 179
1. which would not be possible in a completely efficient market. Broadly I do not think perfectly efficient markets exist. there is a kind of herd mentality going on. It’s an emerging market and in emerging markets typically the values are unknown. so we are getting to a more efficient level. fund flow is not predictable. we are having lots of western influences and western brokerage houses coming here telling us how to understand the markets.Appendices
no capital gains tax and dividends accrue. They would say. every time they buy/sell they have to pay the brokerage. the value compounded through that holding gave him humongous returns. One should go to the financial market for long-term investment. So the approach to investing should be buy and hold and do a careful analysis
. long-term investment is better approach and also the costs are lower in it. So people think that the more active they are. Inactivity generates value and activity does not conduce to better returns. Just as Rome was not built in a day. However. he has to pay all the costs only once. So over a long-run. And my theory is that market gives them exactly what they want in life. In most professions. And the thing is people don’t understand these basic dynamics. But history has shown that activity is actually negatively related to returns.” What we look when making investment decisions or buying a stock. we are happy to own the stock. that has gone up that day. despite the fact that the stock has doubled or quadrupled. and that’s why they make such hard luck stories. activity is a positive and inactivity is a negative in terms of value. So they want something to do everyday. They approach the market from various different points of view. Why do people do that? Because they enjoy going to the parties and saying that we bought the most popular stock or they enjoy saying that we are in the sensex stocks.” People have different reasons to come to the market. value investor. should go for longterm wealth making and buy infrequently and with lot of conviction. People who frequently buy and sell. is we tend to look at the absolute market caps or see what a private party would pay to purchase the business or the company. In stock market it is actually reverse. either undervalued or overvalued. the better the returns will be. Over time all these costs add up to huge amount. the more trading they do. That’s the reason why so many people loose money in the market. As long as we understand that the market is treating the stock relatively low compared to its private market value. while people who invest for a longer period need only one great idea when they buy a stock. Would it pay more than the market capitalisation of the stock or less than the market-cap. i. they have to pay extra for difference between bid-ask price. what we call as value-investing. so the compounded return of the person who engages in one time buy/sell is much higher than who actively buys and sells. ‘I made so much money but I lost it all and I will never go back to the market’. A lot of people want excitement in life.Appendices market in the world over periods of time you’ll find stocks that are irrationally priced. Someone who bought Coke 10 years ago didn’t really have to do much. And so they mess up.e. they have to pay transaction costs. or the PE may have exploded to 50 or other such arbitrary factors. not just from the point of generating wealth and the market then gives them just that. And for the person who engages in frequent trading needs a new idea every week. a person who invests for long-term. to get mature and to build the proverbial mode for the competition. All this is because they don’t understand the fundamental dynamics on which the markets operate. It takes time for the business to unfold. great stocks do not give returns in a quarter or a year.
which involves holding a vision and trying to look at the future and also requires skills. But there are classic examples where I can tell you when passive investment got people in trouble is. But if you segment the market and if you say. Most famous question is that how can you beat Sachin Tendulkar23 and the obvious answer is that that you play nothing else but cricket. the key factor is to look at how the market is valuing the stock and what in your estimation is the value of that business or the company you are buying. so for the period of almost 20 yrs if you were a passive investor in Dow you got no returns. so for the period of 12 years.
How would you find out whether a stock is cheap or not? I think it comes from years of experience in the market. It is my job as an investor to allocate my capital and I take it very seriously. So should therefore play to your speciality. and you can narrow it down to 50-60 stocks that you understand and pick from them. So it is a low cost way to take the advantage of the economic growth of a country. don’t have time to think or read the Balance sheets.
. in 1992 the Sensex hit 4500 level for the first time. whether it is passive investing or active investing is to buy value. The sensex at 4500 level in 1992 was not cheap. is to buy things when they are cheap. The market specialises in 6000 stocks. he will be much better able to understand that oh this is the medicine that will be given to say all the diabetic patients and has a huge potential. for example. If you put it in the context of active and passive investment strategies you are saying. that I am a banker and I am going to look at the banking stocks because I understand that sector or I am in the construction business so I am going to focus on construction-related business. So the trick in the stock market is to buy 1Rs for 50paise. So if a doctor picks a pharmaceutical stock. I believe in active strategy for investment. So the odds improve dramatically because you are already within the industry. just buy the index and get market returns. So the trick in the stock market. but in 2004 4500-level was cheap. but even during that period there were stocks and companies which did well in the stock markets. Passive investment strategy is good for people who actually don’t have time to follow the financial markets. There are more than 6000 stocks traded on the exchange everyday and clearly no one can be an expert in all the stocks. a passive investor basically did not get any returns from his investment.Appendices before purchasing the company. Certainly then the playing field is levelled to your advantage. it did not cross that level decisively until 2004. and meet and talk to the management of the companies. for example when the Dow Jones Index hit 1000 for the first time in 1962 or 64 and it didn’t come back to 1000 Index level until 1982. He is already a doctor and he understands which the best medicine is and which company makes the best medicines amongst all.
Sachin Tendulkar is one of the famous cricket players in the world. Take our own Indian markets.
Now stock market is not conducive to printing a NAV everyday. but any open-end fund. So it’s a vicious cycle that is going on. more money comes in because people are attracted by the percentage of appreciation 13:10. (12:30) I think the MF industry has to come up with a different way to benchmark their returns.
Institutional Investors and MF Industry ‘So much research conducted in the market by so many analysts. you are going to end up not making any money because you then tend to go with the stocks that are moving up. say large-cap or mid-cap and completely ignore one side of the market?
. It may be different with a closed-end fund. But individual investors don’t face that problem. A lot of value investors follow Graham and Buffett’s school of investing and a lot of them have beaten the market consistently over time. The MF industry is very strange animal. That is why you see that over a 14 years period no one has beaten the S&P (Standard and Poor’s). If you don’t increase the NAV money doesn’t come to you and if money doesn’t come to you. and you should look within that circle of competency. who could do it for 13-14 years. in a wrong fashion. they don’t have to match their returns to say S&P or the Dow all the time. What is your view on this statement? See there are two questions. May be in Mumbai 3000 people play tennis half of them loose and half win. in my opinion. You should not try to be ‘jack of all trades and master of none’. so price already reflects about the present and even what is going to happen in the future about the company’. They have to get back and get their credit. you have to look at this over a period of every bull market cycle or every bear market cycle from 2-3 years perspective. which is NAV driven has to face this problem because the MF manager is almost compelled to buy the bad stocks but only because they are performing. You should try to look at a very well-defined specialised area of the stocks you want. so that doesn’t mean that people who lose will give up trying. So the question is not this. people say that since nobody can beat the market why should I try. So it is very hard to beat the market because of the way MF industry is structured. but they haven’t learned that yet.Appendices So you should build circle of competency in order to outperform the market. but he also fell flat. So the whole Mutual Fund business is structured. your returns go down. You should be focused to the area and sectors you have understanding and knowledge about.
Do MF managers concentrate on only a particular kind of stock. The NAV goes up you will be buying bad stocks. It’s a very NAV driven industry and everyday the NAV is reported. And in the long run it is the single most detrimental factor for the financial market. There was one person. Now if you force yourself to look at NAV everyday. They can be inaudibly patient. that is Bill Miller in America.
but unfortunately the stock market is a place where people don’t use their
. and enter new markets and all this has nothing to do with the stock exchange. Individual investors don’t have that problem because they are investing their own money. So yes they want liquidity and they want inhibitions. If the stock performs well liquidity will automatically appear in that stock and individual investors can wait for that. the fact is we know people behave irrationally. for example. But this is wrong. Over time the yes markets prices the securities correctly. Despite knowing this. So there is this funny business going on in the MF industry. But it’s not completely true because now. In the bear market. When markets are up the stock market investors are the most popular people and when markets are down everyone talks about Bollywood in India. like many other value researchers is. What I believe in. In the short-run market goes haywire and there is a bunch of other things going on which causes prices to deviate from their fundamental value. give them presentations. the smart get out’.Appendices Again it is a peculiarity problem. So the trick is to get the stock right. we test that if we buy a stock today and the markets close for 10 years would we still be willing to hold that stock? If the answer is yes then only we decide to buy a particular stock. Because good businesses create value over time. explain to them the mistakes they are making. sector funds and other funds concentrating on mid and small-cap stocks. for every buyer there is a seller and viceversa. In fact the stock market would not exist if everyone behaves rationally. In fact most of the people start investing in the markets when the markets are up and there is a popular saying in the Wall Street that ‘when the public gets smart. launch their marketing campaigns. Similarly for five ten years it is ok. we don’t check its value everyday although it may go up and down. But this business is created in such a way that people think that unless the stock is not quoted well in the Evening Press the company is not performing well or is not doing anything. But generally the sheer size of the money they have make them put the money in the large cap funds because they cannot get a meaningful quantity of a small cap stock. They create new products. there are small-cap funds. Suppose if we buy a house. you don’t need stock quotation everyday. ‘in the short run the market is a popularity machine but in the long run it is a weighing machine’.
How would you be able to outperform the market when the information is available to everyone and they might have acted upon it? Markets work on difference of opinion. Look for different things at different stages in life. as Warren Buffett once quoted. So in the long run market will reflect the true value of the businesses. We may tell them in lectures. As it is generally said that ‘it is not always the most popular girl who ends up getting married to a smart guy’. tell them through books. when markets are at bottom no one is talking about stocks and when markets are high everyone is in the stock market. Businesses perform and keep doing their work irrespective of what is happening on the Dalal Street (it is analogous to Wall Street of USA). for some strange reason it always happens the same way.
So now they are too scared too buy. not understanding the nature of the market. But if you come with the purpose of generating long-term wealth and make long-term investments then only you will generate favourable returns and will be able to beat the market. getting into areas out of their circle of competency like doctors buying technology stocks when they don’t understand the ABC of the sector or the company they are buying shares of. People repeat the same mistakes and if I can profit from it then I will do it. But in stock market the reverse happens. At the bottom of the market when they should be buying they are too scared to buy because previously when markets were up they bought stocks at crazy prices and lost money. There are companies in the bear markets that trade below their cash value and yet people won’t buy that stock while in bull markets people will pay any price to get stocks of the company that are hot or are the next big thing in the market. people will have to break that psychological mind-set they are in but history shows that it will not happen. Say for example if you go to a store in sale and two shirts are selling for the price of one. You might be using it for different purposes and that is why you end up with bad returns and hard luck stories. While when prices go up all of them want to buy shares. Now that is irrational behaviour. This is the classic mistake people make. Stock markets are vehicle of producing only long-term wealth.
So you think discipline is important factor when you are in the stock markets? Yes it is extremely important. not doing their home-work. But people speculate and get in for adventure.
. it becomes more attractive but people don’t understand that. If the prices go up it is good and if it goes down it is bad. To perform well. you will buy more shirts because it is cheaper. But the thing is sometimes when the stock price goes down for some reason. not only in terms of price but also in terms of understanding valuations. when the market goes down people run away instead of buying more they buy less. but that is not the purpose of the market. People base their decisions on price and even professionals make that mistake.Appendices rational senses.
How important is Behavioral Finance in making investment decisions? Can you provide some examples of investor behavior that causes inefficiency in the market from the Indian stock market perspective? And it’s Cause and effects? I think understanding behaviour and psychology is important in understanding markets and in making investment decisions. they don’t understand valuations of a company.
past and logic would not be tempted to make the same mistake. So that time you would have seen a global bull run in the markets. but over a period of time Dow went up from 1000 to 10000 points and that was when the ultimate effect of the triumph of capitalism was understood. He argues that investors are guided by short-run speculative motives. it is reflected in the price? Do stock market participants fathom the information correctly and act rationally or there is a discrepancy? Beauty is in the eyes of the beholder.Appendices Keynes’ pictures the stock market as a ‘casino’ guided by ‘animal spirit’. similarly market sometimes takes time to grasp the reality of particular information. Yes information disseminates and there is immediate reaction but the final conclusion of that may sometimes take even years before the market understand what it holds. but rather in estimating the short-run price movements. I would have been a poor guy. And yes the Sensex for example went up 50 points and the Dow Jones Index went up 100 points. That is why we stress investor education.
. Globally investors behave the same way. Understanding the value of particular information and its implication on a company is an art. But the correct conclusion to that was the triumph of capitalism over communism and the icon of capitalism is free markets. As long as the markets functions in the same fashion there will be booms and busts. But investors who understand history. They are not interested in assessing the present value of future dividends and holding an investment for a significant period. For example. if markets would have been efficient I would not have been in business. and not everybody can understand it atleast in the short-term. So the immediate reaction is sometimes not correct but in a longer term it can have a huge impact on a stock price. So I agree that stock markets act like a casino where people are looking for short-term fluctuations and not long-term value and it is there for their detriment. So definitely markets do not understand and fathom the information correctly.
Do you think that as soon as some information regarding a security is disseminated in the market. But the problem is stock market will always work like it. when they come to the stock market they look at price and not value. but if it is told to ten people only one person understands it. in 1989 when Berlin wall fell and entire world changed. fear and greed and people will do the opposite of what they are supposed to do. In fact they would be able to profit from that. What is your view on Keynes’ picture of the stock market? I think he is right. And it is really important to understand. So yes in the short run markets may have gone up 50-100 points but the full impact was seen and implemented till 1999.
Have patience. so the idea of someone giving you the tip of doubling your money in 2months is playing stupid and that is when you will fall flat. And so the trick to all investing is to buy assets when they are cheap. it will not generate returns. Because the man who is richest in the world generated only 22. Be stock specific you are not investing in the stock market you are investing in the business. If someone comes to you and say that buy this stock and it will generate 30% returns in three-months you don’t want to believe him. because even if you look at your circle of competency and buy expensive stocks. You only need compounded return of say 20% every year and that would work. It may work once but it will not work always.Appendices
How do you think should investors identify good investment opportunities? The first thing is you should always look at your circle of competency. that is what Warren Buffett has done and that is what makes him the second richest guy in just 40 years.5% return every year. The second thing is always you should always buy value.
. You should buy it when you think the company is worth a buck when it is selling in the market at 25 cents.
Markets of countries like UK and USA are saturated. risk level of person will determine what funds he is putting his money in. they should go for active investment strategy because in a market like India abnormalities often occur which causes inefficiency and opportunities for active managers to profit from them. efficient markets are only possible in an ideal world. A more risk loving person might put his money in say mid-cap fund while a risk-averse individual will prefer more conservative funds. mid-cap. you should go for active investment strategy. in a country like India. However. I think that the risk profile of investors determines their choice of investment strategy. Perhaps developed markets like US may be more efficient than Indian stock markets. For example real estate sector is hot today and there are many companies which are overvalued. but not in reality. in India. If you are a more risk-averse individual. India is not as efficient as the developed markets because it is an emerging economy. Therefore. mismatch in expectations also causes inefficiency and managers who are able to identify these mismatch can make returns greater than the market returns. Risk is low in pursuing passive investment strategy. As I mentioned.
Why are Institutional Investors not able to beat the market consistently despite all the efforts and costs they indulge in? Which types of stock (large-cap. the growth rates of companies are stagnant. In fact. In fact there are many Fund managers and investors who have consistently beaten by identifying such sectors before the whole market have got into it. people are not able to match the intrinsic value and the market value of the sector. I4 (Interviewee 4)
Are Indian stock markets efficient? “India is a developing economy and for high growth markets like India. every now and then there is some sector that suddenly grows at high rates and people who are able to identify them beforehand can outperform the market. but because of the overconfidence in the market. small-cap) do you think Institutional Investors concentrate on? Why is that?
. while a risk-neutral or less risk-averse person should go for passive strategy.”
What investment strategy do you think investors should follow? Active or passive?” (considering the evidence that cost involved (both time and money) in pursuing an active management strategy outweighs the benefits and Money Managers are not able to beat the market) Why? Does the risk profile of an investor make a difference? What investment opportunity should be adopted by investors actually depends on their risk profile. Indian markets are not as efficient as the developed markets.Appendices
2. EMH does not hold true. but even those markets are not completely efficient. Even in active strategy. But mainly.
. There always exists some difference of opinion amongst people for same thing. over-pessimism or over-optimism) that causes inefficiency in the market from the Indian stock market perspective? Yes Behavioural finance is actually very important and understanding behaviour can actually help us in not making the errors people generally commit in the market.
‘Investing for the long term means judging the distant future.e. And they do this even if they are not convinced to invest. how society will change. Reaching decisions about such issues cannot proceed from analytical models alone.Appendices
Huge costs are associated with the research they conduct and that is why they are not able to outperform as you rightly mentioned that the costs incurred in their research and other expenses wipe-off the benefits. say certain behavioural factors application for US investors may not apply on Indian investors. over-optimism always exists when the markets are bullish and there is over-pessimism when the bear market is in phase. There may be situation in the stock market when there is a upper circuit or lower circuit.
How important is Behavioral Finance in making investment decisions? Can you provide some examples of investor behavior (irrationality per se – like herding behavior. Some factors that may be true and applicable in one market may not be applicable in India. it is out of the mentality that everyone is making money and I will be left-out. judging how history will be made. Even though their instincts are against it. when there are no buyers or no sellers for a particular stock. may be different and how would they act upon it will also be different. Difference in view and perspective exists like people may view the growth prospects of a company or a industry differently. like how people perceive things. The example of irrational behaviour that I can think of in context to Indian markets is that people don’t want to be left out when everyone is investing in the market or investing in a particular stock. how the world economy will change. Not much idea. Certainly the explanations provided by the behavioural theories are correct. i. Such mismatch in judgement and opinion creates opportunities to get returns more than the market. there has to be a major input of judgment that is essentially personal and intellectual in origin’. Do you think this statement is correct? Are subjective issues important in evaluating investments? Yes this statement is correct. The difference in culture and society. so without understanding also they take a bet in the market. But such situation is rare and does not prolong. There is contrarian opinion that is why buyers and sellers exist at the same time. we see the herd mentality everywhere.
Inefficiencies would go away in a longer-term and there are no surprises in long-term which would deviate the market price from the intrinsic value.in short-term? . Speculators do exist.
How do you think should investors identify good investment opportunities? Individuals do not have access to information and it is not feasible for them to carry out the expenses for collection this information.Appendices What is your view about the Keynes’ philosophy and why? As for the Keynes’ statement on stock market.
Do you think that markets price the securities correctly: .in long-term? Why? Market prices the securities in a longer period.in medium-term? Or . People do take a longer term view. Also. you can easily find this data. traders also exist who carry out speculation. I would suggest that to find out the correct picture of ratio of speculators versus investors look at the statistics or delivery volumes in stock markets. I think a data research and survey would be more appropriate to find the answer to this question. and it is just a way of fooling investors? Yes overvalued and undervalued stocks do exist.
Do you believe in the existence of overvalued and undervalued stocks as against the many researchers and investors who think that there is no such thing in the market. but then there are people who want to stick to their decisions and are not speculating. I don’t think it is completely true. But like I said. Expectations differ in the market. It is therefore advisable that they should search for good money managers in the market and invest through professionals via the mutual fund channel. In fact it is corollary of the fact that markets are inefficient. which results in undervaluation and sometimes overvaluation of the stocks. That is why systematic investment plans are popular in Indian markets.
which differs from person to person and hence all these factors together makes the market inefficient. In MF industry.. They falter in between. capability of management. you have edge over the others. But for individual investors like us there is no such pressure. So therefore they commit mistakes and are not even able to meet the index returns. it is possible to beat the market. everyone has access to same information – everyone reads the same reports. Mr. Market is a reflection of so many people taking decision at the same time and they make those decisions on the basis of the information they hold. etc. Nature of the business. The decision they are making may be based on people’s fear or greed. However to some extent the markets are efficient. we can find any company wherein we believe in and then can wait for that company for a long time to start giving us returns. newspapers. quality of the management. their psychology. So to some extent the theory works. you cannot outperform the market with the help of the past information. and we don’t have a concept of sticking to say large-cap. Skill plays an important role. But using the public information and the insight and through your skills. mid-cap or small-cap stocks. We don’t have that compulsion.Appendices
3. everybody has to perform because there is a pressure from the unit holder that your fund is not performing. or it might be because of your vision and analytical skills which others do not have. evaluates EPS and other accountancy tools for analysis. Institutional imperative that we call it. But there is something going inside the company. Stock prices may not reflect the intrinsic value of the company because of the use of these factors in decision-making.
. Ranjeet Hingorani
Do you agree with the EMH? To what extent do you think the theory holds true? Do you think that it is possible to “beat the market”? If yes then can you please explain how it is possible? Empirical evidences prove that passive investment strategy are better and more beneficial than active investment strategies. as the markets reach efficiency and the cost incurred in discovering the strategies to outperform the index outweighs the benefits received from them. So on the face of it you’ll find that the valuations are fair. We can take our own time. That might be due to the nature of the business. out of some idea they hold. Is this true? “I do not agree with the efficient markets theory. so they have to go for momentum stocks that are hot in the market. such factors should be taken into account while selecting stocks for investment. which is intangible that no other person can see but you can see. their interpretation of the information. stocks on which there is lot of news going around in the market because the bonuses of the FM is also linked to the returns.
A person who is risk averse. Risk profile of an investor may not necessarily affect his choice of investment strategy.
. In most of the instances. those stocks should not be related to each other. sectors. When an investor is making money. for him risk becomes irrelevant and once he loses money he realises what he has done and becomes riskaverse but then it is too late. When market falls. So he can go for index stocks or index funds and he will be much better off than many active investors. They have also gone through the dot. active investors loose much significant amount than passive investors. But certainly there are industries. they are over-researched. which are dull. behaviour is the same.”
What investment strategy do you think investors should follow? Active or passive?” (considering the evidence that cost involved (both time and money) in pursuing an active management strategy outweighs the benefits and Money Managers are not able to beat the market) Why? Does the risk profile of an investor make a difference? Individuals investors who do not have expertise and understanding of analysing companies.
Do you think that Indian stock market is as efficient as the capital markets of other developed countries like US or UK? Why? Also there is no difference in the efficiency level of the stock markets in India and other developed markets because the people are the same.Appendices There are 6000 companies listed on exchange and certainly all the analysts are not tracking all those companies. the costs incurred in their research and other expenses wipe-off the benefits. So they ignore such companies or sectors. because he has made one correct decision in investing his risk taking capacity increases as he becomes intelligent and brave in his own eyes. when they actually are able to beat the market.Many researchers have proven that nearly all mutual funds and other institutional investors fail to beat the market on a consistent basis and that they underperform the market. markets and sectors can straight away go for indexing. because the expenses of later and cost to the investor is less. But it doesn’t appeal to the institutional investors.
Institutional Investors: . Investors should have a much unrelated portfolio and reduce the risk of the portfolio. So risk profile for me is a relative term.com boom and bust like India and India is also now witnessing the real-estate boom. companies which are in the Index. They are generally tracking the companies of the sectors which are hot. And then he takes that additional risk and that is disastrous. So for example I hold 4 stocks. because those companies don’t give returns in shorter term. and the greed exists everywhere.
its market capitalisation will also increase and the same market cap comes into buying criteria.
‘Investing for the long term means judging the distant future. there has to be a major input of judgment that is essentially personal and intellectual in origin’. liquidity is again a function of demand and supply. mid-cap. those 5 years will not come back and also you have many companies to choose from. So finally that is the question of belief. See. how the world economy will change. foresight and judgement to decide whether to be there with the company for 5 years and make money. And another thing is that they are only comfortable with buying large cap stocks that’s why they are over-researched. That requires a lot of skill and it doesn’t come overnight. And that projection doesn’t come so easily. they pile on large-cap stocks. which everyone does not possess. So maybe today the liquidity is not so high but if you think that this is a good company and in few years it will grow and give good returns then automatically the liquidity will come in that stock because of increase in the marketcap. how society will change. how good you are at projecting the future. small-cap) do you think Institutional Investors concentrate on? Why is that? They are on interest. say liquidity. Do you think this statement is correct? Are subjective issues important in evaluating investments? Stock market is a game of probability. Now if I buy a good company and eventually its stock price increases.Appendices Can you explain the reasons for this? Or provide evidence when a fund or a company has been able to outperform the market over a consistent basis? Which types of stock (large-cap. So that judgement is required and that is matter of skill. There also lies the allocation of capital concept.
Do you think this happens because of other factors also. i. Small and mid-cap stocks do not have liquidity and these managers cannot easily exit when they want. You have to be sure about what are venturing in to and that comes with thorough research and analysis. judging how history will be made. I think they do this because if they don’t get good returns they can say that they bought a good company. So rather than venturing into something that is unknown or less popular. Institutional investors generally concentrate on large cap stocks. and they don’t want to take that risk. it comes with a lot of experience and understanding of the market and businesses.e. Once the opportunity is lost. which is the most difficult
. Reaching decisions about such issues cannot proceed from analytical models alone. So their returns are ultimately market returns as they concentrate on Index stocks. Essentially you need that intellectual. their bonuses are linked to their performance and so they start taking higher risk without understanding returns will come or not.
Identifying such companies is the key to investment decisionmaking. I agree that that judgement is relative and you might go wrong but then again there comes the skill into picture.
How important is Behavioral Finance in making investment decisions? Can you provide some examples of investor behavior (irrationality per se – like herding behavior. There is not much volatility in their prices. that I am not going to buy business which can loose money and exit from the market. Their intrinsic value and market value go together. And there is so much greed in the market that people are not interested in such stocks because they don’t have much short-term movement. the company is there since last 40 years and it has been market leader. I certainly agree that you should be confident and very sure about your decision and there lies the concept of Warren Buffett’s circle of competency that says you should know and understand what you are doing and investing into. There is again a philosophy into investing. but when the market will fall. Like Bank.e. everyone needs a bank account and the bank is nimble enough to come out with fantastic products. The bank’s services are always desired. these companies generate returns higher than the market. whose management doesn’t do bad loans and it is careful about the cost. what I am trying to say is that people might have identified such companies. Another example is of a company in the paint industry. it is number 10 in the world.Appendices part to me. Temporary setbacks are possible. my companies will not loose their value in the market or very nominal decline. But that is what the skill is all about that you are different from others. The company has not lost money. a good bank. Asian paints. but these companies don’t get overvalued. although this surety is again relative. such companies don’t fluctuate too much in their market value. though you know they are going to do well right now. over-pessimism or over-optimism) that causes inefficiency in
. i. So they deliberately keep the prices stable. the company has pricing power in the industry and they are coming with higher-end products where margins are huge. The management of such companies don’t want speculators to come in their shareholding and make their prices volatile. So today by investing-in in such companies I might not be able to beat the market. I am ready to say no to 99% of business which this philosophy says that have the chance to loose money. Through understanding of the business you are sure that this business is going to quadruple in next 4 years. I should be able to decide how much capital I should allocate to a particular company. So I have to be sure that the business I am getting into never loses money. can I allocate a percentage of my capital to that company for 5 years without making much difference to my portfolio. but there is an Economic goodwill of that business that can again generate that kind of money in short period of time. Paint is always needed and desired and now the margins are improving. Also. They have stable growth and because of this stability most of the people stay away because there is not much short-term movement in the price. But over a long run.
Most of the people try to complicate things and then solve it and then get things done. You should get things done in simple ways. without understanding that there are other factors which will de-accelerate the growth. You have to know your limitations and work on those limitations. Everyone is investing in the market and making money then why should I be left-out. it is reflected in the price? Do stock market participants fathom the information correctly and act rationally or there is a discrepancy? The expectations sometimes of the market or company are so high that people actually misprice the securities. that is what I would call as overreaction bias and as a result no one gets any returns. So without knowing ABC of investing or the company. Bottom-line is. There is a tip-behaviour in the market.in short-term? .in medium-term? Or . in short-term it is only a voting mechanism
Do you think that as soon as some information regarding a security is disseminated in the market. So finally it will average out somewhere down the line. you should not get carried away by the market. and it is just a way of fooling investors?
. So higher expectations exist in the bull market and people are overoptimistic.
What is the role of discipline in stock markets? Discipline is also the most important part in making investment decisions. people also start investing because everyone else is doing it.
Do you think that markets price the securities correctly: .in long-term? The market prices the security correctly only in the longer-run.Appendices the market from the Indian stock market perspective? And it’s Cause and effects? Behavioural finance is very important while making investment decision. People overreact to the good news and pay higher price for the securities. On the basis of just one piece of information people under-react or overreact and ignore the other factors that may be equally important in price determination.
Do you believe in the existence of overvalued and undervalued stocks as against the many researchers and investors who think that there is no such thing in the market. which comes through experience and also you should always select good businesses. because no one wants to do the hard-work and still want to make money. you need skill to identify good investment opportunities. You have to be disciplined while making investment in the stock market.
the paint industry in India.
How do you think should investors identify good investment opportunities? For investment opportunities. There is no short-cut in life and you have to be patient to be able to consistently beat the market. overvalued and undervalued stocks do exist in the market.
. go through annual reports. Moreover. And there comes your circle of competency.Appendices Yes. you should be able to understand everything about the company or business you are intending to invest in. finding out what are their plans for the next 10 years. For e. And then finally you have to make the judgement whether the company is good or not and its product will remain in the market in the coming 10 years. the product is desired and it has no alternative. they have pricing power and margins are huge.g. You will have to read a lot. understand its competitive position in the market. in that sector there are companies which have sort of monopoly. investors should look for such companies. what will future hold for this company. which have market leadership and edge over others in the market. whose products are desired and will always be needed in the market. But that sector has not been paid attention by institutional investors. who make constant innovations. how good the product or service it is selling is. Also. you should not be guided by short-term motives. You need to envisage whether this business is going to be there in the next 10 years. where there are not much of government regulations. understand the company and the sector it is in. how good its research and development department is. You can create wealth only through long-term wealth. you should only get into the industry or business which you understand. You have to get into the nitty-gritty of the balance sheet of past few years. From these aspects you have to refine your research and select stocks of good companies. find out companies which have consistently made profits and will be able to do so by looking how their management is.
its always better to pursue the active management strategy. i. mainly through specific stock selection and sector selection. it takes time for the market to understand that information. yes. In volatile markets like India. And a lot of funds actually have beaten the market consistently over the past several years. But frankly in terms of practicality. India is a volatile market. But having said that. the growth prospects of the sector and other such factors is the starting point for investors to identify good investment opportunities. is it undervalued or overvalued. But if in 2003 you would have expected the Index to go to 13000 from a level of 4000 in 2-3 years time. over a longer period of time. Do you think markets price the securities correctly? Over a longer period yes. to consistently beat the market. which will do better than the market. Identifying the fundamental factors of a sector in terms of turnaround of the sector. and you would have made much more money than through active strategy. higher than the index weightage. Indian stock markets are not as efficient as the markets of developed economies. But I think Indian markets will still take time to reach the level of developed markets like US or UK market.
Is it possible to beat the market consistently? It is possible. will not generate good returns. the valuation of the sector. but then by and large it is possible in India to outperform the market consistently. to find 2-3 stocks from a longer perspective. it is not a very stable market and often times what happens is like there is not proper dissemination of information. then you can outperform the market. At times you might underperform maybe for a quarter or two. say for example sector like cement now when you know that infrastructure of the company is
. in theory it holds true. The no. of course now things are changing as India is getting integrated with the other global markets. because you don’t know what’s going to happen in say next 6-months or further ahead. then passive investment strategy would have been awesome. Now obviously if a company is within that sector. passive investment strategy will not work. And that is not difficult in a country like India. At given points in time you will find certain sectors doing exceptionally well so if your weightage in those sectors is good.Appendices
4. I5 (Interviewee 5)
What is your view on EMH? Firstly about EMH. whether the markets will go up or down. it’s efficient over a longer period of time but in shorter term say 3-6 months over even a year sometimes market may not be efficient.e. of participants is not completely broad based.
there is a huge amount of tracking going on the media is all over the place so finding those opportunities are getting difficult by the day. The idea is not only to get the sector right. as the markets reach efficiency and the cost incurred in discovering the strategies to outperform the index outweighs the benefits received from them. that they might have identified the sectors or companies that are doing well now or those which have a good outlook for the future. meeting industry associations then you can identify good investment opportunities and its not very difficult. that’s the reason it is important to be ahead on the curve. But in my view. but things are getting difficult in the sense that you pick up any mutual fund review and you will find most of the people are invested in similar sectors or stocks by and large and there
. Timing is therefore extremely important in making entry to and exit from the market. and if you keep monitoring these through reading.
So many researchers and analysts exist in the market. 2-3 years ago it was easy in India to identify such opportunities. At this point in time a lot of smart money gets out of that sector and then looks for something else. Is this true? You are right in a way that majority of the people are not able to beat the market and the reason is precisely this that they do not get in early in the market. Today the market is very-well researched.
Empirical evidences prove that passive investment strategy are better and more beneficial than active investment strategies. it is difficult you got to get it right. Obviously there is going to be demand for cement and you should try to gauge the demand supply equation in that sector and identify if the supply is more than demand or vice-versa because that will be the determinant of the actual price of the cement in the market. Many people say that we don’t time the market it’s not possible to time the market. You need to be early and everybody can’t be early.Appendices improving and a lot of investments going-in in infrastructure. You got to get in early and be at the lead rather than a laggard because then you will only make index returns and not extraordinary returns. So these are kind of ideas that you can get.
Shruti: You should be first-mover in the market? Yes. but to get it at the right time because it is not easy to determine the turnaround. Otherwise what is the point in identifying something which everyone has got into. So it is not possible to outperform the market as the price already reflects all available information When you start off. meeting management. After some time everybody will be starting to talk about it and that’s when you see the performance of that sector tends to be muted despite all the fundamentals still holding true.
And I am admitting that it is not easy but the fact is it is not impossible either.
What investment strategy do you think investors should follow? Active or passive? Why? What factors do you think should be taken into account? Does the risk profile of an investor make a difference? In a country like India where people look at the Index on a daily basis. In fact interest rate is one of the most important determinants in terms of flows into the emerging markets. everything is not company fundamentals. a lot of information is getting disseminated on websites and through news so really I mean that differentiating factor is really diminishing.Appendices is hardly any differentiation. which greatly affects the whole economy. For example if the interest rates are rising. Today you might outperform but cannot guarantee for tomorrow. How quickly and what your access to that channel is that will determine whether you having cutting edge over others. And maybe in the next 5 years even Indian markets will be like other developed markets in terms of efficiency level. Wherein beating the index will be a real challenge. atleast in India. Is it correct? It is quite possible The way industry is getting so much attention and so many people are involved in tracking that. So people don’t understand that risk. The skill is there but then so many people have it It is skill in a way because everything is not company researched. the client might come back to you after 6 months and say that look buddy the index has given 25% return and you have given me a 15% return then why should I pay you anything. So interest rates is very important in determining in which phase the market will go because flows from FIIs affects the emerging stock markets to a great extent. commodities.
You do you think at the bottom of the day it is not skill that will play role but luck. The index would give a 20% return but you structured the portfolio such that the returns generated were 15%. then obviously the money will not flow into equity and it will go out from the emerging markets (India) to more developed markets. It is not possible to beat the market consistently. also how successful the person is in terms of managing the money. that high
. managements are coming out and talking about their performance. Apart from the quantitative aspects of the companies there are many other factors like government policies. and you might find a client who says that I am risk averse and I am happy with a 10-15% return so you might structure a portfolio which is relatively safe for him. which determines how the company or the market will perform. price of crude. etc. a lot of it is got to do with the flows in the market. how is the global interest rates cycle. what is happening internationally and lot of other factors.
In context of Institutional Investors: Many researchers have proven that nearly all mutual funds and other institutional investors fail to beat the market on a consistent basis and that they underperform the market. small-cap) do you think Institutional Investors concentrate on? Why is that? There is herd mentality on the streets. everyone wants to pile on it. When you missed first 20-25% of the rally then you should not get into it. because then the whole world has got into it and the smart money has actually gone out. which is why large-caps are always traded at a premium compared to mid-cap stock. That is the fact. but there are some MF that have consistently beaten the market. if it is a mid-cap fund obviously it will be a mid-cap focus. the costs incurred in their research and other expenses wipeoff the benefits. when they actually are able to beat the market. most MFs do not beat the market.
Does such behaviour causes undervaluation of mid and small-cap stocks and therefore inefficiency in the market? It does. There is a bit of comfort and much more transparency in the large-caps. 80-85% of the stocks would be mid-cap. when the markets fell. if it is a diversified fund.Appendices returns come with high risk.g. In most of the instances. what is diversification. What happened in the mid-June (2006). it certainly does. mid-cap.
. E. of a newspaper article. Do you think investors in India are not very well-educated in comparison to investors of developed markets? That would be a fair statement to some extent. Can you explain the reasons for this? Or provide evidence when a fund or a company has been able to outperform the market over a consistent basis? Which types of stock (large-cap. mid-caps plummeted 40-50% when the large caps were down 20%. And that is why in India the MFs are not allowed to promise any particular return in equity markets. because they do not understand themselves their risk profile. The comfort-level in investing in large-caps is much higher than the mid-caps so generally people tend to stick to large-caps. It all depends on a mandate. which is why the regulator encourages everyone to go into the equity markets through MF. But if there is a flexibility then most people will focus on the large-caps given the facts that liquidity is important from fund management perspective. That is why you got to be early in the game. Emerging markets are generally volatile. Suddenly when you see something doing well.
And if there is some gap between mid-cap and small-cap stocks then it becomes apparent. it became quite evident that mid-cap stocks were not moving and a lot of momentum was going on in large-cap stocks. You may term it inefficiency. It is not easy to kind of anticipate and determine but it is important.e. When the whole world becomes pessimistic. It is not that people don’t know about it. then at that point in time people take their money out of large-cap and invest it in relatively liquid mid-caps. generally it is time to go reverse.Appendices Liquidity is one of the main reasons why this happens. But it is a known inefficiency in the market. large-caps are generally well-researched. When the rally is starting it is better to be in the large-cap stocks because if you are wrong it is easy to get out of the large-cap stocks. And those companies start going up in terms of share prices and that segment start picking up until it is overvalued and the shift occurs back towards large-cap stocks. And typically after a sometime large cap need a particular rally or a decline and when large-caps tend to become overvalued. Over a period of time market recognises all of this. when there is a herd mentality. In 2000. the technology sector was performing so well that they increased their exposure in it.
Behavioural Finance It is fairly imp because a lot of time what happens is that there is generally consensus in the market and the consensus normally is wrong. Also. But if you are wrong and you select mid-cap and if the markets start to go down then you might have difficult in exiting. Comfort level for large-cap is certainly higher. There are a lot of fund managers sitting abroad and for them it is easier to get information on large companies that will not be necessarily true for some of the mid-cap companies. difficult is in the entry and exit cost because of the illiquid nature of the stock. Even the diversified Mutual Funds had 30-40% exposure in technology stocks. i. For example a month and a half ago (September 2006). The cost of getting-in in the small-cap stocks is high. This was because of the performance. May be that initially they held 10-15% position in tech stocks but that
. diversified funds we are talking about. everyone knows about it. well-covered.
Do you think that if someone takes that risk and identify good opportunities in mid and small-cap segment then he can outperform the market? I wouldn’t go that far. People don’t want to invest money but play with the market. everybody was in the equity markets and everyone was buying technology stocks. And that’s the cycle and it’s a very typical pattern. that’s precisely the reason.
it will wipe out everything they have.Appendices must have grown to 30% because the other sectors was going down.000. Many people do that. in 2002-2003 when the markets reversed you could buy the technology stocks at 10-20% of their values in 2000. So that is the human nature and this sort of behaviour is often seen amongst Indian investors.000 and 15. But as the market goes up and as you make money. Suppose I have bought some shares and I told you to buy and you happen to miss that opportunity and I made a profit from it then you’ll feel so bad having missed it. people were looking at 10 years story of technology companies’ performance in India.
So what you mean is that the risk taking capacity of people increases as they make money? It’s not the risk capacity. but despite that people were not buying the companies that earlier they were ready to buy at 80 P/E. even after burning their hands many a times they still do that and end up buying things because someone else has recommended you. And mind you ‘losing an opportunity hurts you more than having actually lost money’ (42:40). People were justifying stocks trading at P/E multiples of 100 and 80. people don’t want to get in the stock market. So your size of investment at that point of time is also very low. its not that the tech story has completely gone from India. But the attractiveness of the stock market is so overbearing that they can’t afford to miss anything like that. So that’s the other extreme. Talk about the reverse. so they just buy whatever is recommended to them. People don’t have time to analyse and get the information on the stock. you play within your mean because you are scared of losing money. you would not feel so bad because I have lost money too. On the other hand if I bought something and lost money and you bought something and lost money. it is still a great sector. Typically when the markets are plummeting and are at their bottoms. because they have their own work and business to manage. This is why there is so much tendency of over-speculating that you go beyond your mean. Even in down-cycle none of the technology companies in India were making losses. There was so much concentration on tech sector. Because you have gradually
. But what had happened was that the entire ten year story was priced in a period of 6 months time of timeframe that was the problem. I mean it is still true. they very well know that if this Rs15000 halves or even goes down 30%. I am talking about large-cap companies. say you invested only Rs. you increase your Rs100 investment to Rs1000 and 1000 climbs to Rs5000 and 10. Seeing that your neighbour is making money and you are left out hurts more than when you actually loose money in the market. 100. chasing stocks with no fundamentals at all just because someone on the street or your stock-broker has recommended you.
Can you outline some other irrationality of investors apart from what you just mentioned? Over speculation.
What is your view about the Keyne’s philosophy and why? I think it is a fair comment and I don’t dispute that. They are not interested in assessing the present value of future dividends and holding an investment for a significant period. There are so many things influencing your mind
.in medium-term? or . the real money that is. But out of those 40 years. In fact it should be the other way round. And that is the reason for this kind of behaviour as described by Keynes.in short-term? . Reason being that the information might not have been incorporated completely. In short-term there might be fluctuations.Appendices built it up in lots and your Rs 100 investment has actually climbed to the multiples of that. Nobody thinks of their capacity. There may be other external or international factors (psychological) like if there is a war going on somewhere and their markets and other markets are not doing well.
Do you think that markets price the securities correctly: . the annualised returns are better in the stock markets than in bank deposits and fixed income market. the profits were actually made in 4-5 years. Very few people in the Indian markets are there for a long-run. It is therefore the psychology.
Keynes’ pictures the stock market as a ‘casino’ guided by ‘animal spirit’. there might be discrepancies in terms of pricing but in a long-run definitely markets prices the securities correctly. no question about that. They will rather put money in stocks or funds where they’ll get say 20% returns in 6 months or 1 year.
Does this behaviour exist even in developed economies? Yes. It is a fact and it is not going to change as long as the markets exist. Out of 40 years in the stock markets in USA (the numbers and details is given in Peter Lynch’s book). He argues that investors are guided by short-run speculative motives. but quite frankly it never happens. this behaviour exists even in the developed economies. Greed is therefore one of the irrational behaviour that investors succumb to which affects their returns in the markets.in long-term? Why? Medium-long term. This kind of behaviour is actually driven by the greed. for that matter no one wants to wait for 5 years. people might expect companies and markets in India to do well. there might be disbelief in terms of what is going on. but rather in estimating the short-run price movements. Nobody wants to wait for 40 years.
. why has the market not recognized it. and it is just a way of fooling investors? Yes overvalued and undervalued stocks exist all the time
How do you think should investors identify good investment opportunities? Let us talk about undervalued stocks. find out the reason for the numbers declared and depending on that assessment the stock price will correct. the stock prices crashes or rises depending on what was the expectation and what was declared. questions asked from company’s management.It is in a sector which everyone hates. When you are scanning the universe. In short-term reactions occur. The moment the management gives some indication markets starts to price that in. However in long-run people find out – there are analysts meet. It is a lot of hard work. There could be undervalued stocks because: . but no one had the courage to put-in in equity having seen what happened in 2000.Appendices when you are buying or selling that in short-term there is discrepancy in pricing but in longer run it is corrected because the information sort of populates down (people understand the information and what lies behind it). There is a reason and it is not that it can remain undervalued for a very long time because the market remains inefficient only for a very short time.
Do you believe in the existence of overvalued and undervalued stocks as against the many researchers and investors who think that there is no such thing in the market. For e. no one likes that particular sector So the whole idea is to find out why is this company standing out. and the moment the expectations doesn’t match. in this market you are all alone’. Even in bullish markets you will find companies which are undervalued because they are ignored by the analysts.There is not much of coverage in that sector or company. . in 2004 everyone knew that the market is undervalued. they confirm whether this is a one-off thing. There is immediate reaction to say earnings expectations. other factors also settle down and this particular factor gains priority and people understand their former mistake.No one is looking at it . you need to study about the company and the industry it is in. They were all waiting for companies to start performing well.g. a lot of time you will find undervalued stocks. ‘The best way is to do it yourself.
is there some accumulation going on and such factors.
Do you believe in technical analysis? Not from stock selection perspective but from stock entry and exit point of view. you might be ahead of the market. But look for growth prospects of the company and profits that is the only tool you have to see if the company will do well. But having selected a particular company. There would be other markets trading at 12 P/E multiples.Appendices But how does an individual identify the company or the industry? There are different approaches for it. if it still holds or not.
. changed the way it does business. That is the general perception internationally. So would you go and buy that? So if you adjust the P/E ratio to growth and look at PEG instead of P/E you might find an answer there for identifying good investment opportunities. engineering or anything.’ Never look at past and base your judgment because it is history. There are lot of databases available and you can find out that in a particular sector the 3 companies are going extremely well n stock market and there are 2 companies which are actually languishing. ‘Market likes growth and it is willing to pay premium for that growth. Lot of qualitative factors would have come in. The fact of the matter is Indian earnings are growing @ 25% p. You should do a lot of reading and you can identify sectors and company from there. it might have moved to international shores. Even today India is one of the most expensive markets in this region in terms of P/E multiples. You can’t go and select stocks on the basis of technical analysis. A lot of things would have changed. it might be tapping new markets. what are the range in which you can typically buy and if breaks a particular level then you need to be a little careful. nobody wants to touch them. and a particular company is getting into it maybe through designing. Then your due diligence starts and you identify the growth opportunities of this company. So if they are trading at 16-20 times it might be justifiable. That puts things into perspective. but you should be patient. It does help you in selecting your entry and exit points. So it is a good guiding tool but not from stock selection perspective.a. The company might have changed its technology. the expected growth. The future is completely different. So you can go back and check your fundamentals. So the point is. might be acquiring some company. Suppose there is a new technology coming-in that you have heard about. you got to adjust that P/E to growth. So start from there. So I wouldn’t ignore it completely. You can either go for a top-down kind of approach wherein you look at the macro scenario and narrow your selection Or you look at within the sectors that are doing well. you should go back and look at the charts and you can check if there is volume happening in that stock. Through PEG. but their corporate earnings’ growth is 510%. P/E would not determine the outlook.
the theory might have been true. But every individual has brain and using his/her brain each one interprets or views things differently. if you devote too much time and energy on academics. So sometimes there are excesses in the market which brings things to the equilibrium.
Empirical evidences prove that passive investment strategy are better and more beneficial than active investment strategies because as the markets reach efficiency the cost incurred (time and money) in discovering the strategies to outperform the index outweighs the benefits received from them. And so a cycle forms. It is good in theory but in practise it does not hold true. In real world information is analysed by people. Efficient market theory is helpful in understanding markets and it can serve as a benchmark from where to start.oh this lady buys from me everyday and I think I am selling too cheap’ and so he starts to increase the price of his vegetables.
. people overestimated its potential and there was overcapacity of steel and the World War happened. then you will start ignoring your health. And this cycle brings things to the equilibrium. And it was overvalued. Let us say for example. There are cycles in the market. You will realise that this vendor is now cheating and you decide to try someone else. Excess keep happening. who interpret it differently. your extra-curricular activities and you might even start devoting less time to your family. I6 (Interviewee 6)
“Efficient capital markets theory assumes that two people think alike. domestic. Innovations keep happening. etc. EMH is correct in theory but if it will be implemented in real life then no market will exist. Now. there were books in that era written that in 5 years all the work will be done by Robots. Had the analysis been carried out by computers. Similarly when the semiconductor chips came in people overestimated its potential too. but if we will think that markets are going to completely efficient then markets will cease to exist”. And anything that becomes excessive starts devaluing something. The mere presence of brain in humans deviates markets from efficiency level as a market comprises of people and people make the markets. you think that he is selling cheap and he thinks he is making a profit and so the deal takes place and you buy from him everyday. But you are expected to balance-out everything and this balance is nothing but bringing equilibrium to your life.Appendices
5. this how this world grows. there are two vegetable vendors and you decide to purchase vegetable from one of them because he is selling cheaper than the other. Take an example of your personal life. But that is not the case. Now a behavioural part will come in this deal and that vendor will start thinking that . people overvalue or overestimate the power of new innovations. we don’t have robots doing our household work. That is what happened in 1929 about the steel.
he is an activist. one has to be focused on his basics and only concentrate on what he understands rather than getting driven or tempted by others. if I don’t invest in the ‘hot’ sector I will be losing customers and I will be losing money. markets. management they can understand. people will think ‘oh he has lost his touch’ and they withdraw money from his fund and invest in other funds.
Why are fund managers not able to outperform consistently? (Irrational behaviour also highlighted) Active managers are not able to perform consistently because they try to be jack of all trades. if the fund manager is not investing in the ‘hot’ sector because his logic and judgement says not to and he underperforms compared to others. So let me also participate in the sector. But it is easier said than done. Very few money managers. I will only invest my money in what I understand.
. But his performance again soared and the other managers actually lost tremendous amount of money. So fund managers are making these mistakes because investors are forcing them to make this mistake. we think that we know more than anyone else and that is where problem arises and that is why we underperform. We as human beings consider ourselves as super efficient. For a brief period his performance was down as compared to other active managers who invested in IT companies. If we actually contain to stick to our basics then only we will be able to beat the market through our skill through our vision. But no one knows when this bubble will burst otherwise no one will invest in the bubble. so I won’t invest in it. in 2000 he made a statement that ‘I don’t understand IT industry and therefore I don’t invest in it’. In those brief periods of excess.Appendices Is this true? A passive manager says that markets are going to go and down and up and down then why should I waste my efforts in predicting these ups and downs. Let me be in this market and invest in Index. you will do better than the others. Because people behave differently and there is excessive for somebody then I will have the opportunity to make money out of this excessive by taking a reverse position from what others are doing. Moreover. That FM might then think that my business is suffering. They got to understand this and only focus on companies and stocks which they understand. Very simple. it is fantastic. I don’t understand IT. When this bubble will burst I will walk out. An example for this can be given of Warren Buffett. products. But an Active manager thinks that because God has given me brains so I should use it. Because if you continue to put your money in what you know better. so I will get the average and I am happy with the average. When they generally evaluate the FMs performance they look at 3-6 months or a year record and then pick up the fund. whose business. Investors create pressure on fund managers and that is why they get into momentum stocks. but they can’t be an expert of everything. fund managers and other investors actually follow what Warren Buffett said.
And if there are cycles you will always make money if you predict the cycles. they start thinking that they drive the markets. So they need to focus on their strengths. So active managers can make money and beat the market because there are cycles and there is nothing in this world. It is all human nature. They come on television channel and give advice on which sectors to invest in. Today they recommend something and tomorrow that stock will move up. it is possible to beat the market consistently. Glamour is also coming in this industry. You will see people all over the world investing in India. However. How can you know about India sitting in United States when you hardly visit India? What is on the Internet. no human being can predict all the cycles right at the right time. So you need to focus on few cycles in order to get returns higher than the average. You got to live here to understand the complete scenario economic. That is why he is a smart investor. problem lies with the implementation. so if I am making more money. Just because the implementation is wrong. This is all glamour and they become overconfident about their performance. However. not everyone can continue to outperform the benchmarks all the time like Warren Buffett underperformed for the brief period of technology boom. People have actually lost focus on their strength. the problem is not with the theory. He will actually take opportunistic advantage of the market. there has to be equilibrium. Another irrational behaviour on part of FM is that if they start to outperform market and make profits. magazines and TV will not give the complete picture of India. which company to invest in. the problem is the way that theory is implemented. So I got to be smarter than others to make money.Appendices Investors put pressure on FMs to perform every quarter and the FM actually comes under pressure to retain the market share and they start looking at everything and basically become jack of all trades and master of none. But problem lies. newspapers. But they don’t understand that they are part of the market and they cannot drive the market. social and other. Those who did it they are successful and we have examples of such people. Also. The point is. the problem doesn’t lie in the theory be it behavioural finance or be it value investing. A smart investor will never drive the market. someone will have to loose it. I stress. everyone tries to predict all the cycles. This is the biggest problem in MF industry. Everyone says India is a big story. But then over a longer run. But if India is a big story why are farmers in India committing suicides? This is something which they cannot monitor from United States.
. there is nothing in this world that is not cyclical. theory cannot be wrong. And in the process they become average people and an average person will give you average returns.
if a heart surgeon will use it.
Is technical analysis helpful in making investment decisions? I think it is a very good tool but only for the people who understand it.Appendices Is there a difference in developed markets and emerging markets in terms of the irrational behaviour outlined above? The human psychology remains the same everywhere. And today the world is integrated.in medium-term? Or . People actually think it is a casino where cheap money can be made but believe me there is no cheap money in this world. it will result in a fiasco. Equipments of a brain surgeon will only be useful in his hands.in short-term?. Otherwise both the markets are similar. however it is more prominent in emerging economies like India and less in developed economies. over-pessimism or over-optimism) that causes inefficiency in the market from the Indian stock market perspective? The manner in which the money is invested is wrong. If people have behaved in a manner in past it is very likely they will do it in the future because humans have the tendency to repeat their mistakes or behave in a similar fashion.in long-term?
. only the impact of the mistake has a different intensity. Other reason why the impact is severe is because the volatility is quite high. People will have to take a long-term perspective in stock markets. .
Can you provide some examples of investor behavior (irrationality per se – like herding behavior. If in the short run a fund does not perform. the liquidity is low but in developed economies the impact of such behaviour is less severe. Therefore the nature remains the same. Do you think that markets price the securities correctly: . bulk of the investments that is done in the market is done with the mind set of making short term profits and that is why people don’t make money.
What is your view on the Keynes’ pricture of stock market? Keynes’ picture of the market is absolutely correct. People are investing money in stock markets to generate short-term returns. Technical analysis is helpful because it predicts the behavioural patterns of the investors. investors withdraw their money from it and invest in other funds and so FMs are also pressurized to select sectors and stocks which will generate short-term returns and so they fail to show their performance. But they will have to take long-term calls. the mistakes remain the same. Once probably reason for this is that Emerging economies have are smaller markets compared to the developed economies. And I think this phenomenon is worldwide.
You should then predict the cycle of that industry. Likewise you will find 4-5 areas or industries which you understand. You need to continue to focus on your strength and identify your strength. Evaluate the company using the Porter’s five factor model and then come to conclusion whether you should own it or not and accordingly make your decision. and their management style is. Pick a company and see where it stands in that cycle. how is the future of the industry and the growth in it. When you invest you should always evaluate the company in the sense that is it sustainable for a longer period and can it sustain the same growth level of its cash flow to generate returns for you. Check the track record of the manager who is managing that fund and check not just 1-2 year track record but a longer record. You should never invest in a company with the intention to sell it tomorrow if you want good returns in the market. Always buy a business which in your mind is sustainable.
How do you think should investors identify good investment opportunities? An individual should never invest on his own. You should have a business owner perspective when you are deciding to buy the stocks of a company. Then you meet the management and understand what their vision is. then you will only get average returns. Invest through active managers and for funds which are for long-run investment.
.Appendices Over longer-term markets prices the securities correctly. Always buy stock with the mindset of owning that particular business then only can you make money from that investment. But if you invest through passive managers. Fund managers exist for that purpose.
. It is indeed very helpful in investment decisions”. He argues that investors are guided by short-run speculative motives. when they see prices of stocks climbing. is the theory valid in Indian stock markets? EMH does not picture the true world. that contains the markets from becoming efficient. without understanding the valuations they purchase those stocks and when it busts they all curse the stock markets. People are driven by greed.
What is the role of Behavioral Finance in making investment decisions? Can you outline some examples of irrationalities on part of investors in the market? Behavioral Finance provides a platform to learn from people’s mistakes. and know that they may be unable to control themselves in the future. Especially when the markets are on a bull run. this problem is more severe in Indian markets. though they are efficient to some extent. Putting-in money on tips. to modify and improve their overall investment strategies and actually profit from identifying these mistakes. And believe me they don’t understand a bit about the company they are putting their money in. unavailability of some information that affects valuation of the company. Mature markets of US and UK may be more efficient than India. What is your view on this statement? Keynes made a fairly correct statement. misunderstanding. though sometimes even they are driven by this ‘animal spirit’. In fact even my cook wanted me to recommend him stocks to put his money in. People show problems of self-control. In real world there are many factors like irrational behaviour of people. Conversely. actual investors do exist.Appendices
6. etc. overconfidence. In India also stock markets are not completely efficient. In fact. I7 (Interviewee 7)
What is your view on EMH. investors become extremely pessimistic amid downturns. However. credit managers investing in the stock market. They are not interested in assessing the present value of future dividends and holding an investment for a significant period. doctors. bank clerks. assuming it will continue to do so. you will find housewives. software professionals. but even they are not completely efficient. but rather in estimating the short-run price movements. Investors get optimistic when the market goes up.
Keynes’ pictures the stock market as a ‘casino’ guided by ‘animal spirit’. everyone is here to make cheap money. It is actually like a casino for them. and getting emotionally attached to the shares are all examples of irrational behavior seen in Indian markets.
In 2002-2004. and it is just a way of fooling investors? Markets are often driven by greed and fear of the people.in medium-term? or . which causes stock prices to move beyond their intrinsic value causing overvaluation of stocks. But it was the fear and over-pessimism that was guiding them. This is a clear indication of existence of overvalued and undervalued stocks. people actually were paying 50x the price to get the same company.
. Nothing went wrong with the company. it was still selling its products.”
Do you believe in the existence of overvalued and undervalued stocks as against the many researchers and investors who think that there is no such thing in the market.in short-term? . I myself found some very good companies during that phase whose stocks were selling in the markets at unbelievably low prices and no one wanted to buy them. People also generally tend to forget the past and other factors that have an effect on the company and give so much weight to the current information that it leads the price deviation from its intrinsic value. I have actually seen that the offices which used to be packed with traders and investors 2-3 years back had no one except the operators. Being an analyst. as has been seen in 2000-2001 Internet bubble. Similarly when people suffer losses because of the mistakes they commit of buying stocks when market is highly overpriced without understanding fundamentals.in long-term? Why? “In short-term prices often deviates from their intrinsic value as it takes time for people to understand what lies behind the information. they are so scared of the market that it causes companies selling sometimes below their cash value.Appendices
Do you think that markets price the securities correctly: . However over a long-run the true picture is identified and hence markets price the security correctly. generating profits and running its business. While 3 years back. Stock brokers actually used to telephone their clients and convince them to come to the market atleast for a few hours.
Varied schemes for varied objectives . It is difficult to beat the market on a consistent basis. Fundamental research gives returns better than the market. it is a useful tool and can aid to time your entry and exit from the market. nevertheless it is not impossible. so many FMs just play the momentum. then with the help of technical analysis. I8 ((Interviewee 8)
Indian markets are not efficient and certainly not as efficient as developed markets of US and UK. This discipline means not getting carried away by the market. nor can it help in identifying good investment opportunities. And you need to have a disciplined approach of investing’. Although I agree that majority of the mutual funds are not able to beat the market. Capability and credibility of a company plays an important role in generating returns. ‘It is the ability that will always keep you ahead of the market. In order to solve this problem. fund managers need to be disciplined and they should not hold very risky portfolio because everyone else is doing so.above causes pressure on fund managers Because of the pressure.
. They should only be venturing into industries and stocks which they understand. you can decide when should you buy stock of X company and when should you sell it off.Fund managers have to report day-to-day Net Asset Value (NAV). Not following the herd mentality – ‘Just because everyone is doing it I should also follow the herd’. but then everyone cannot be a winner. out of short-term motives of getting high returns. . Explanation of why fund managers are not able to beat the market: . which is an important cause of all the FMs to underperform. It has been seen that stocks follow a particular pattern. Intellectual capital. resisting the temptation of generating high-returns in short-term.
Is technical analysis important in making investment decisions? Is it helpful in selection of good investment opportunities and outperforming the market? Technical analysis cannot help you in outperforming the market. However.Appendices
7. And once you have identified that you want to invest in X company. So in the bullish markets they outperform but in the bearish market they do not. out-smartness and diligence can help you to outperform the market along with the points discussed above.
the costs incurred in their research and other expenses wipeoff the benefits. how society will change. Funds that have outperformed consistently: HDFC mututal Fund’s scheme called ‘HDFC Euity’. Moreover. smart FMs exist and make good returns while others just pile on into that stock and most of them end up losing money. when they actually are able to beat the market.
Many researchers have proven that nearly all mutual funds and other institutional investors fail to beat the market on a consistent basis and that they underperform the market. at this point in time. they should invest in the market through professional investors. which is disastrous.
‘Investing for the long term means judging the distant future. In most of the instances. Sundaram’s mid-cap fund. the others get into it. . When you start doing well. since the investors do not have access to information and resources to analyse and understand that information as well as the fund managers do. Reliance’s growth fund. This is a common mistake. Institutional investors are not able to outperform the market also because: . judging how history will be made. rather than doing it themselves. how the world economy will change. Templeton’s Prima fund. DSP Merrill Lynch’s Equity fund. Reaching decisions about such issues cannot proceed from analytical
. hype is created and that sector becomes hot. Their motive is to generate safe returns for their investors. In fact. .If a well-known FM has identified something.Appendices What investment strategy do you think investors should follow? Individuals should also adopt active management strategy. Can you explain the reasons for this? Or provide evidence when a fund or a company has been able to outperform the market over a consistent basis? Irrationalities and reasons why FMs underperform: . And also. If investors want stable returns and are risk-averse they should adopt passive strategy.Thrill of out-performance that makes you take riskier option. you start to increase your exposure in the market and put-in more money in the market. stories are built.Outperformance is not the motive of many schemes. risk profile will affect the choice of the strategy adopted by them.so many schemes they put the money into are designed in a way that they are not supposed to beat the market. DSP Merrill Lynch’s opportunity fund.
The train platform and train is very crowded. Subjective issues lies in your judgment power. Do you think this statement is correct? Are subjective issues important in evaluating investments? Can you further elaborate this point from your perspective and give an example. over-pessimism or over-optimism) that causes inefficiency in the market from the Indian stock market perspective? And it’s Cause and effects? Behavioral Finance is indeed very important in making investment decisions.Appendices models alone. there has to be a major input of judgment that is essentially personal and intellectual in origin’. peak hours of local trains in Bombay (Mumbai). Own example is of Pantaloons Retail India Ltd.30pm. It is 5. Someone was talking to his companion in a loud voice and was using the
.. The company’s products and services were appreciated in the market. etc are some examples of subjective issues that are important in decision-making. 5 years back everyone was sceptic about Pantaloon’s performance and its retail concept.
How important is Behavioral Finance in making investment decisions? Can you provide some examples of investor behavior (irrationality per se – like herding behavior. But then this change was bound to happen because the Indian market is changing and consumer’s tastes and preferences are also changing. I identified this company 5 years back when it was trading at Rs 30. when you identified a particular investment opportunity. since it is an emerging market. It was a right decision and like I envisaged within 5 years the company’s stocks are trading at Rs. One of the examples is herding behaviour. long before it was ‘popular’ in market and also detail on that. Pantaloons was one of those three stores. My rationale was that there were very few big retailers in Indian markets into apparels and supermarket and only 2-3 of them had national presence and outlook of increasing their stores in India. capability and credibility of the management of the company you intend to invest in. So retail boom was what I envisaged and I was confident about it. it was a new concept otherwise earlier people used to buy only through individual small retailers. Yes I strongly believe that this statement is correct. To some extent this change is aligned to the market patterns of other developed economies. herding without understanding why they are getting into a particular sector and without understanding why they are buying stock of so and so company. I will explain this through an example. your skills and ability to identify good opportunities and analyse companies and stocks. how discipline you are in the market. 30 in 2001-2002. from your own experience. I always try to map the US and UL markets and try to identify and watch what changes these economies had 50 years back and relate that to India. They were not ready to accept the change that will take place in the retailing market. 1600 from Rs.
but rather in estimating the short-run price movements. I think his explanation is correct and this happens in the market.in short-term? . BOMB. existence of both
.Appendices word Bombay and someone pushed him and he could only utter Bomb. He argues that investors are guided by short-run speculative motives. and a rush of panic occurred in the station.. Short-term markets are driven by irrational investors. For example. it is reflected in the price? Do stock market participants fathom the information correctly and act rationally or there is a discrepancy? No.
Do you think that as soon as some information regarding a security is disseminated in the market.in long-term? Why? In a longer-term. If someone recommended buy. the information that is disseminated may not be apprehended in the same manner as the company wanted to show.in medium-term? or . there is a discrepancy. Few people heard his utterance and started shouting BOMB. everyone started running-off and started acting irrationally. Exactly this is how the stock market participants behave in the market. However.
Keynes’ pictures the stock market as a ‘casino’ guided by ‘animal spirit’. For example. their efficiency. external events like a bombing in UK will result in crash of Indian markets despite the fact that such an event actually has not affected the Indian economy or its industries and companies. Each individual will understand and henceforth react in a different manner. What is your view about the Keyne’ philosophy and why? In regards to Keynes’ picture of the market. BOMB. No one even once tried to understand what happened and caused this irrational behaviour causing trouble. everyone will follow the advice without using their logic and so happens for the selling advice. in a longer-term the true picture will show and prices will reach their intrinsic value. They are not interested in assessing the present value of future dividends and holding an investment for a significant period. But is this not what markets are for?
Do you think that markets price the securities correctly: . Without understanding and knowing people just do as others do and even rational investors and professional managers follow the crowd. It is just panic from investors or an opportunity for speculators to make profits by driving the market away from its fundamentals. In fact.
Markets are like a pendulum which swing between the phase of overvaluation and undervaluation.
Do you believe in the existence of overvalued and undervalued stocks as against the many researchers and investors who think that there is no such thing in the market. and it is just a way of fooling investors? Yes.Ability to identify excesses on both the sides up and down. definitely overvalued and undervalued stocks exist in the market.
How do you think should investors identify good investment opportunities? Through.Appendices the buyers and sellers in the market prove that same information is interpreted differently and there is rational and irrational action on the basis of that information.
.Strong fundamental research .Disciplined investment methodology .
there are more researchers. Information disseminates at the same time as soon as it is available and the dissemination is also higher leading to markets becoming more efficient. So the competition level has increased. Mr. But claiming that it always does is a utopian idea. There will always be contrarian views. But today even domestic institutions have become large.
Shruti: Is there a discrepancy between what the information holds and how people interpret it? Vishal: Yes and no.
. And over a period of time. For example. But such chances are rare. Now. much more technically qualified people in finance than earlier. But through public information and historical prices it is difficult to outperform the market. Besides. in India markets were not efficient 4-5 years back because the information was hotchpotch.
Shruti: Do you think that the markets always price the securities correctly? Vishal: Yes markets price the securities correctly. Say insider information. lot of foreign institutions and hedge funds have come into the market. For this reason only buyers and sellers both exist in the market. if you have information that other people in the market do not hold. mostly domestic institutions. a person may interpret a particular piece of information to be great but the other may not. analysts. Therefore the markets are much more efficient than they were few years back. even today. The research on the markets has improved manifolds. However. Indian markets would become more efficient. Vishal Jain
Shruti: Do you agree with the EMH? To what extent do you think the theory holds true? Do you think that it is possible to “beat the market”? Do you think that Indian stock market is as efficient as the capital markets of other developed countries like US or UK? Why? Vishal: Agree with it. If everyone will view the information and interpret it in the same fashion then no market will exist. In my view. retail investors are becoming more educated. then you can make money out of the market and outperform others.Appendices
8. But today the regulations in the Indian markets have improved from the stock markets and also the regulator. 3-4 years back there were only a few players in the market.
So say in 5-10 years down the line India will also reach that stage and the growth level will reach average and companies will have growth level of say 8-10 % as against the 2—25% they have now. Suddenly it has popped-up and it’s a big story. In fact it was stumbling down in that duration.
Shruti: In 2003 no one knew that market will reach from 4000 index-level to 13000 in 3 year’s time. Few years back no one talking about telecom sector. there are constant changes happening to index. But in India. There the index managers review the index on an active basis. companies are getting
. which will give above-average returns and add value. In this period. $4-5 trillion is floating in index funds. Companies in India are now having 20k-40k employees which wasn’t seen 4-5 years back. If whole market is passive there will be no market. it is not necessary that active fund managers will outperform the market as they grossly did in the past. Companies which do not fulfil the criteria move out of the index. sectors and companies grow. When economy develops/grows. therefore there would always be some sectors ‘poppingup’. India is developing market. For eg. If you are a 100 million company you can grow @15-20% but when you become 10 billion then you can’t sustain the same growth level. They become large and competitive. so it becomes difficult for even one company to out-beat the others because mergers and acquisitions occurs.Appendices Shruti: What do you think about the argument that if everyone will pursue passive investment strategy then the amount of research carried out will diminish resulting in markets becoming inefficient? Vishal: In market there have to be active managers. And people have been able to get excellent returns through investing in this sector. companies start consolidating and growth rate comes to average levels like what has happened in the developed markets like US. In India. So a person who pursued passive strategy in that period was actually worse-off for 13 years. Because the active managers are taking call on the market. So in a few years time they will also come down to average and then it will be difficult for active fund managers to beat the market. if a company is not growing atleast @20-25%. where a company growing @ 10% is considered big and good. the passive fund managers are there and exist. Vishal: Obviously there will be periods when Passive fund managers will underperform compared to active managers but then even the vice-versa happens. investors who might have pursued indexing earned well. Hence active managers can make money. Looking at this point of time. In developed markets like US and UK passive investment strategy is ingrained in people. Having a year-on-year growth of 20% is not possible all the time. it is not considered good because of the nature of our economy. Indian companies are also reaching economies of scale and they are becoming big. as they are able to do now. But before that period 1992-2003 the market did not do well.
And the criteria for Index companies being a part of index is also changing ad Index providers are also learning. despite that there are people like Peter Lynch. I want to be invested in the best companies and that is reflected in the Index. 100. However. I don’t want to take this risk. I might as well put my funds in an Index for 4-5 years and I believe in it because if our economy is going to grow. even though we are purely a passive fund company. There has to be a guy who has to go wrong for some other guy to go right and vice-versa. put 25-30 purely in indexing. There has to be research done on stock and there has to be a contrarian view in the market. So there is a role for active fund manager as well. Active funds also have value. Then only will both the philosophies will survive. Say if he has Rs. the instances of active managers outperforming the market are going to reduce. who is
. I don’t want to put my money with some Fund manager who might be there today but might not be there tomorrow. However. When a client approaches us. because an active manager has outperformerd the market this year doesn’t guarantee that he will be able to outperform in the coming time.
Shruti: What investing strategy should an investor follow? Passive or active? Vishal: I think it should be a combination of both. We always suggest them that a part of your portfolio should always be in active funds. Active fund managers have to be there otherwise passive guys will not survive. What is gradually happening now and will continue to happen is that Indices in India are getting reviewed much more often. And obviously the skill is there and that skill of active guys should be valued.Appendices into the index on the basis of valuation and that valuation is on the basis of which the active fund managers are playing on. But now gradually even the indices are going to get all the more efficient and they are going to select better stocks.
Shruti: Research has shown that Active Fund Managers are not able to beat the market on a consistent basis. so obviously the large companies are going to benefit the most. Due to this. in fact everywhere.
Shruti: Why is that? Vishal: Simply because there are periods when active fund managers outperform the market and indexing doesn’t generate returns. we never say that put all your funds in indexing. Do you think skill plays an important role and people with certain skills will always outperform the market? Vishal: Ya it does. another 30-35 in active funds and the rest can probably be put in debt. Bill Giller who have done so. which it will.
Thus. he would probably prefer being with the index. The classical case of outperformance I have seen is the case when active fund managers are benchmarking their returns with the wrong index. when looking at the performance and returns of active managers.
. He would not want 30-40% return that may not be stable.
Shruti: In fact there are more than just a few people who have been consistently outperforming the market. there is skill.
Shruti: Do you think that the risk profile of an investor makes a difference in his investment strategy? Vishal: Yes. But obviously there is no comparison. There are people giving good returns say 40% (As against Nifty’s 20%). But how many people can actually do it. So what do you think. History shows that there are a very few people who have done it. he is content even if he is just getting the market returns of say 20-25%. So if you are investing in mid-cap companies. you should compare your returns with Mid-cap Index. who are investing in mid-cap companies and comparing their index with Nifty Index. I don’t know who that one person is. I am not sure that an active manager who has beaten the index can do so in the future as well and also that he will be able to beat the market by a huge percentage. I don’t want to make that call. Especially in India. definitely. If you are consistently doing it. is a big question. There were people who were beating the market on a consistent people.Appendices performing today but might not be performing tomorrow. So I agree with the statement. such factors should also be taken into account.
Shruti: Institutional Investors (question 3) Vishal: Even if Fund managers and Institutional Investors are able to beat the market that number is going to be small and lot of their money is going to be eaten-up by the cost. If the investor is risk-averse. but they are not there today.
Shruti: Then what do you think about people like Peter Lynch and Warren Buffet who have been consistently outperforming the market? Vishal: They are exceptions. I don’t think it is possible for any active manager to grossly outperform the market on a consistent basis and with time it is going to get all the more difficult. it is their skill or matter of luck? Vishal: I’m sure it is skill.
We are the passive fund and we charge 0. in May 2006. he is also going to give the market return. Logically if you are putting-in money at 12000 Index then you should be willing to put at a 9000 Index level. This is because he is benchmarking his returns with the index.25% of the assets being managed.Appendices
Shruti: What do you think are the reasons why Fund Managers are not able to beat the market? Vishal: In India. When the Index again ramped-up at 11500. This behaviour does not make sense. all the markets slumped and I saw that we were getting huge redemptions. So there is very little chance that he is going to beat the market. This would mean that he is just going to play around with 20-30% of the stocks in his portfolio to generate returns higher than the market-returns. It was surprising that no one came in and bought. 80% stocks they have in their portfolio are there in the Index. the IIs and FMs are not able to perform well. everyone is in the market to buy. the active guy also has the same. To what extent can he do that? The information dissemination is the same. If you look at the portfolio of active FMs. so they have to hold the Nifty stocks also. which again is a big call he is taking. What information we have. Everyone is looking at the Nifty. forget about active or passive. when the economic condition of the country is same and there is no problem.25%. If he is completely off the Nifty and his selection goes wrong he would be in trouble and he would not want to take that risk. So eventually he is also going to give you index returns. There are very few people who have the guts to really go out and buy when the markets are falling. people again started buying-in and investing. For example. So indirectly he is also tracking the index. People were ready to put in money when Index was 12000 but when Index is 9000 no one wants to invest or no one has the money or guts to invest at that time. So an active FM has to first outperform the index by 2% to beat the passive guy and get at par at what Passive Fund is giving. Simply because the psyche is that he also cannot deviate much from the index because of the risk that he might underperform. when fundamentally nothing has gone wrong in the economy or companies. So he (active) has to work that much harder. the expense ratio that is charged to the investor on an active fund is 2.
Shruti: Do you think there is a herding behaviour amongst IIs and FMs? Vishal: There is a herding behaviour across all the investors.
Shruti: So do you think that because of the pressure from investors to outperform the market or follow what is ‘hot’ in the market. Eventually. I have seen that when the market falls everyone is there to sell and when the market goes up.
That’s what we believe in. he should.
Shruti: If the manager or analyst stays disciplined. uses his judgement and does not act out of pressure and has the guts to go against everyone.Appendices Vishal: Yes. and of them are quick to react to that pressure. This would result in lot of advertisements and marketing happening for indexing a lot of awareness coming into people and a lot of information flowing. Even his fund is underperforming his clients will shift to other fund managers and then he will not have the money to manage. they have this committee where they have mentioned that when the pension funds would be allowed to invest in equity it will only be through index funds. That is why most of the active managers are also investing in Index. You’ll then find a lot of retail institutions getting in and a lot of talk happening about Index Funds and then a lot of MF’s getting into it. I mean even if he has guts to sit in the market and also sit with his portfolio even when he is underperforming and still believe in his philosophy but people should also have faith in his philosophy. we will start reaching efficiency any passive strategy would be made popular and start working. So that will be a big regulatory push towards Indexing like in USA. For people to have faith in him and his philosophy it would require exceptional skills and a lot of experience.
Shruti: Do you think as economy will grow.
. because such faith comes with a lot of years of experience like it took Warren Buffett forty years to build his reputation. At the end of the day. do you think he will be able to outperform the market? Vishal: Yes I think so. In India there is a huge pension fund market but they are not allowed to invest in equity. Government is now talking a regulation called the OASIS report. Vishal: Definitely it will be and also there would be great regulatory push down from the regulators. there would be a lot of institutions coming into index funds and getting into it. But see it is like the ‘chicken and the egg problem’. Once this happens. it is business. there definitely is pressure and there is also peer pressure and all FMs are aware of that. But it does not happen. I might have a philosophy but I got to survive in the market. we are the only Fund House into passive funds And we believe in the coming time the market is huge for Passive Funds. Most of the portfolios replicate the Index. In India we don’t have huge domestic corporations barring VTI or a LIC or a General Insurance company whereas in US there is a huge pension fund market. And once these guys come into indexing there would be a herd mentality again. So it will gain momentum as the time goes by.
you are going to loose. the distributor is earning. So you have to first make that story. everyone craves. That’s why you nowadays find in India a lot of new mid-cap funds coming in. make subjective decision?
. There is so much of information today and everyone starts creating a panic scenario like markets are going to plummet. If I don’t pay them I will not get money. At the end of the day I have to make money. I will have to generate a story and sell that to people. The FM is earning. If other FMs are selling a new idea I also will have to get into it. Its a business and at the end of the day I have to survive in the market. The large-cap stocks are overvalued. People will buy that story. So it’s like flavor of the month that’s why today the whole flurry of investors are into mid-caps stocks & funds. registrar. I have to keep generating the ideas and selling those ideas to people. But at the end of the day the MF and money managing companies in India and across the world has to survive and keep coming up with new ideas. pay salaries & bonuses. MF companies are paying the distributors more and earning less. Because what happens is everybody panics. the India story is over.
Shruti: Does passive strategy allow you to do that.e. Why is a MF also selling in the market? Because it is getting redemptions from retail investors. Custodian. from its own customers. There is a herding. I think it’s a bone in the whole system. So I come up with mid-cap stocks and generate the mid-cap story but then suddenly the mid-cap stocks are over-valued. Asset Management Company is earning irrespective of whether the investor is losing or earning. It’s like a chicken and egg problem.Appendices Shruti: What kind of stocks do you think institutional investors concentrate on? Is there a bias? Vishal: There obviously is a bias towards large cap stocks. So now what’s next? Then I might shift to small-caps. So that mentality goes across the board right from retail investors to MF’s customers & FM’s to institutions and all other players in the market. so that is irrational. The investor is being taken for granted. I have to get the money. i. the accountant are earning their commissions or salaries but at the investors expense. Shruti: Can you provide some examples of irrationalities on part of II’s because of which they are not able to perform well despite all the efforts they put in research & analysis? Vishal: Herd mentality not only from II’s but also from retail investors. So they have to have diversification in their funds. it’s the investors who are losing. I have to make a fund and then I have to go & sell that fund otherwise I won’t survive. So what is the new idea I have come up with or the new story I have come up with? Say now I have come up with mid-cap funds and then I sell the mid-cap story. And that is very irrational. In Indian market selling is very distributor led. But I don’t blame them.
And I am studying others behavior and I know what not to do. You might think that everyone is stupid and I am smart.
. So you need inputs from everything. It is on the customer to do that. you might think that I will do the opposite because the people are stupid and you might shot. inputs from fundamental analysis. technical analysis. we have done all the kind of valuation models. If the investors think market is going to do well he comes & invests through the passive funds because he does not believe in active fund manager & therefore he uses his own judgment. Passive FM never comes and asks you to make a call on the market. We have exhausted all active fund management ways.
Shruti: Do you think that if people’s behavior causes inefficiency & they act irrational. I don’t know to what extent it would work.Appendices Vishal: Passive strategy is a vehicle to use your judgment and take a call on. different types of research and the passive investment also. Some day this might go wrong & you don’t know why has it gone wrong. VISHAL: each strategy is bound to bomb at some point of time. I don’t think one thing works all the time. Fuzzy logic. I might invest according to behavioral patterns and some day it might bomb on my face. Base your judgment on all the inputs. Even if you try to understand people all the time you are not you will always be able to outperform. Don’t base your decisions on just one thing.if everyone investing in the market and buying in and the markets are going up. Every strategy bombs at some point of time.. But that might also bomb on your face. does it work in different scenario. And you won’t know what else has gone wrong. For e. so what’s next? So therefore the behavioral finance has come up. Fundamental also works at the end of the day you have to look at numbers. All these things might work or might not work. & outsmart them. behavioral finance and your own judgment. it is stable. Shruti: What is your view on behavioral finance? Vishal: I think people have run out of ideas to beat the market and that’s why all these things are coming up.g. what you are going do then? Your judgment might go wrong. You might even need behavioral finance. Similarly in order to time the market you also might need technical analysis. so we can learn from their mistakes and outperform? Nobody has been doing consistently well. “Fundamental guys say technical is bullshit & technicalists say fundamental is crap” But each thing has its own value. and use those and the make your decisions. And the market might just keep going up. So you got to take inputs from everything.
Everyone out there is to make quick money. it goes right once. Need a disciplined approach. Without using their judgment & research people listen to the tips from the market and act on it. a proper asset allocation and a proper strategy to do well in the market.
.Appendices Shruti: Can you outline some of the irrational behavior of investors? Vishal: In India there is tip behavior. First time they go right. People in market are driven by greed. it goes right twice it just bombs on you. They are happy & decide that this guy is always right & next time they put Rs1000 & then the market completely bombs on him. First time they put Rs100. So basically they follow tips. second time they put Rs200 on that tip. second they again go right. they don’t look at it as investment.