Will entrepreneurs be guided by Keynes or Graham?
It is now a little over three years from when the pandemic and the associated lockdown took centre stage in India and the world. There was uncertainty about how we would deal with the pandemic and nervousness about how businesses would navigate this period.
We could look at past incidents such as the SARS outbreak of 2003 or the MERS-CoV outbreak of 2012, but they were both limited in their spread to specific regions. COVID-19, on the other hand, was a global pandemic for which there was neither a playbook nor an endgame that could be used as a precedent or a model. The miracles of modern science, vaccines and the medical community got us through the pandemic. As did endless Zoom and Teams calls.
Throughout this tumultuous period, the Mutual Fund industry managed to maintain a healthy trajectory. No wonder then that there is much that I and the entire Mutual Fund industry should be grateful for.
MF AUM has grown at a CAGR of over 13% pa from FY19 to FY23. This is a healthy rate considering the previous blockbuster growth of over 23% pa from FY14 to FY19. Just as a measure you could benchmark this to say bank deposits. For the same four-year period (FY19 to FY23) bank deposits have grown at 9.4% (source: RBI). Another way to look at this would be by way of annual net inflows in Mutual Funds. Let us consider only inflows into Equity & Hybrid schemes, including passive schemes, for simplicity purposes.
The table below depicts a picture of robustness of flows into these schemes over the past four years.
Table of MF Flows as per AMFI
|Equity & Hybrid MF Sales* (Rs. in crores)||5,30,308||4,92,726||8,87,658||8,16,982|
*Includes equity funds, hybrid funds and ETFs
Just for context, let us now juxtapose this number to automobile sales and cement sales over the same period:
|Equity MF Sales (Rs. in crores)||5,30,308||4,92,726||8,87,658||8,16,982||1.54x|
|Cement Demand * (mnT)||325||329||354||392||1.21x|
|PVs Volumes ^ ('000s units)||2,775||2,711||3,069||3,887||1.40x|
*Source: Jefferies Report, Jan 05, 2023. These are analysts’ estimates for the Industry
^Source: SIAM, Axis Securities
There are many reasons for these outcomes, but that is not the purpose of this data. All of us in the industry should be grateful for such outcomes. We are grateful to investors who have put their trust and savings in the industry. We must redouble our efforts to do our best for our investors and educate and handhold them through the ups and downs of Mr. Market.
Mr. Market is capable of being volatile but can also experience prolonged periods of going nowhere. The Nifty-50 index plunged nearly 40% in slightly over a month in February-March 2020 in response to the pandemic and lockdown. From that low, it then rallied 137% by October 2021, over a period of 18 months. In the subsequent 19 months, the markets have traded in a tight range by moving up and down but without any net progress. That’s the nature of Mr. Market. How should investors deal with Mr. Market?
For those uninitiated with Mr. Market, here’s how Warren Buffett unfolded the concept in 1987 in his letter to Berkshire Hathaway Inc. shareholders:
“Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe to be most conducive to investment success. He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.
Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions, he will name a very low price, since he is terrified that you will unload your interest on him.
Mr. Market has another endearing characteristic: He doesn’t mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you.”
The analogy of Mr. Market is one that investors in the market would do well to remember. In my experience, investors and entrepreneurs tend to be driven more by what was described by the economist John Maynard Keynes as ‘animal spirits’. Keynes explained how the economic cycle could be volatile because of the changing ‘spirits’ of the businessmen involved.
“Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits – a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.” (161-162) — John Maynard Keynes, General Theory (1936)
Legendary investor Benjamin Graham was of the view that you could ignore Mr. Market! But we know from experience that investors and entrepreneurs are biased towards action over inaction. When they feel bullish, entrepreneurs are positive about the future and are willing to take risks, which leads to the risk of errors in capital allocation and investment. They extend current trends of demand and profitably indefinitely into the future. They worry less about potential risk and cyclicality. And when times are adverse they turn cautious and pull back on their investment plans. Arguably, investors commit the same error in allocating excessively to an asset class when past returns appear to be favourable and in holding back when recent returns have been poor. The onus to educate investors against such errors falls upon us fully and squarely.
But let us focus back on entrepreneurs. I was reminded of Keynes’ ‘animal spirits’ when at a recent business newspaper’s flagship conference there was a discussion over this topic or rather a discussion on the lack of ‘animal spirits’.
Here, let me quote Amitabh Kant, G20 Sherpa and former CEO of NITI Aayog:
‘We need to sustain this (growth) over a three-decade period and I have been a long-term believer that this cannot be done without the private sector actually accelerating the pace of investments. The gross fixed capital formation in India has to rise, it has presently increased to about 29% but at its peak it was at 35-36% in 2004 and that needs to be accelerated. The real point is that right now the corporate balance sheets are really good. The bank balance sheets are really good. The NPAs are at an all-time low of 4.4%. The government gave out a bonanza of Rs. 1.45 lakh crore to bring our corporate tax to international levels. It is really time to ponder over whether the country would have been better served if those resources would have been put into infrastructure or would have been used to push consumer demand. If the private sector is not investing adequately, the animal spirit of the private sector must rise to the occasion now. In my mind, it is absolutely imperative. Now is the time for the private sector to go and take all risks.’
That sounds like an exhortation to the private sector to raise its animal spirits and invest. In addition to the points made by Kant, the Indian corporate sector has witnessed a boom in profits during a difficult period for the economy. For the Nifty-50 companies, profits rose nearly 65% from FY20-FY22. This is a period when real GDP barely changed. If we include the estimated profits for FY23, Indian companies (Nifty-50) would have added nearly Rs. 3 lakh crore to their annual run rate of profits, which is an 83% surge in annual profits in FY23 vs the base of FY20.
Just for context, in the five years — leading up to FY2020 — profits of the Nifty-50 compounded at just 5.7% pa.
Will this profit boom, combined with tax breaks and healthy balance sheets, trigger an investment boom? Clearly, the initial conditions seem favourable for a boom. Further, the banking system has healed and has the appetite to grow credit. To be clear, a GFCF rate of 29% is a healthy number and nothing to be scoffed at. The aspirational rate of 35-36% may not be healthy or sustainable as we discovered in the middle of the previous decade when companies went into bankruptcy and banks had to take on loan losses.
It is now up to the entrepreneurs to choose their course of action or inaction. Will they be swayed by ‘animal spirits’ or will they demonstrate studied indifference in the face of the manic-depressive Mr. Market?
As investors, we hope for prudent capital allocation from the companies we invest in. We would rather that they are not infected by ‘animal spirits’ or that they remain completely indifferent