CIO Speak: The best laid plans

Recency bias is quite prevalent in investment decision making. When a certain asset class or stock performs extremely well, market participants tend to gravitate towards the same. The contrary is also true – when a particular asset class or stock is underperforming, investors tend to shun the investment opportunity. During periods of market boom, investors tend to embrace higher levels of risk and as a result, gravitate more towards mid and small caps. 

The decision to increase exposure to mid and small caps is largely influenced by their recent good performance in booming markets. In increasing markets, there is a tendency to forget the higher risk quotient of such stocks – as a result, portfolios get skewed towards mid and small cap stocks and assume higher than mandated risk. On the other hand, when markets are in a downturn, investors tend to avoid the mid and small cap segment and instead allocate more to large cap stocks.

Highlights

• If you observe the long-term performance of both equity and debt indices you will see that while there have been periods of underperformance for both the indices, there has also been recovery and outperformance.
• In tough bear markets like 2018 or during times of crisis like 2020, return from equity and debt may converge, and equity may even underperform debt. However, this is always temporary.
• Over the long-term, equity has comprehensively outperformed the debt index. More specifically, if we were to observe the 10-year rolling returns of debt (Dynamic debt fund) and equity (Nifty 50 TRI) indices over the last decade, we would observe that 97% of the time, the equity index outperformed the debt index.
• Historical returns play an integral part in informed decision making. On that front, point-to-point returns can be a bit misleading because they mask the volatility in price movements. Instead, opt to review rolling returns while making investment decisions – these can better capture price movements and offer a more holistic perspective.