There are so many
instances when you come across a newspaper article and the heading itself tells
you that there is something wrong with the story. Recently, one such story
talked about equity underperforming PPF over a 20year period. As a proxy of
equity, the writer had taken Sensex data. This story was published in a leading
business daily and has been widely circulated in social media.
First of all, the
timing of the story is interesting. The author highlights this in the opening
paragraph. The line catches attention. It stresses upon the fact that in spite
of the last 40% upside, equity underperforms PPF. Well, those who understand
compounding know that 40% for a year is lower than 8% per year for 10 years and
far lower than 9% per year for 20 years.
Secondly, the
writer has picked up one period (just one period) to prove a point. Anyone with
an understanding of statistics knows that this is too small a sample to be
called representative of anything. (For more detail, please see this story … http://www.cafemutual.com/News/Don’tbefooledbyaverages~124~Cli~FinancialPlanning~61)
One must question
why only this period is picked up for the analysis. Is this some kind of a
Bollywood movie script that one is talking about “Bees saal pehle ki baat
hai…”? Exactly 20 years ago, the Sensex was at a high point. While the writer
mentions the 40% upside in the last oneyear of the analysis, he forgot to
mention a similar rally between August 1993 and August 1994. Well, that rally
was not similar to the current one. Here are the numbers:
Month

Sensex closing
value

One year change

August 1993

2,633.79

74.20%

August 1994

4,588.16

Month

Sensex closing
value

One year change

August 2013

18,619.72

42.02%

August 2014

26,442.81

While the Sensex
has gone up by 42% in the last year, it had gone up by 74% for the year at the
start of this analysis. This means, it is not just the current point that is
high as mentioned by the writer, even the starting point of his analysis was
also a high point.
Third, PPF cannot
have a onetime investment. It requires annual investment. This will completely
change the result if you allow annual investments both in PPF as well as
equity. Those familiar with the concept of SIP in equity would understand this
point.
Fourth, and very
important – the writer does not seem to know much about the index used. Sensex,
the index he has used to represent equity is a principal return index and not a
total return index.
A principal
return index reflects the movement of the stock prices and ignores any
dividends paid out along the way. A total return index adds back the dividends
also.
Why are we
suggesting that this is a critical point? The writer has considered reinvestment
of all the interest in case of PPF and hence got the benefit of compounding. To
do a fair comparison, even the equity dividend should also be considered
reinvested.
We constructed a
hypothetical index assuming various dividend yields and added back all the
dividends. We used Sensex data as the base for the calculations and assumed
three different dividend yields (annualized), viz. 1.0%, 1.5% and 2.0%. We had
to do this since Sensex Total Return Index is not publicly available on www.bseindia.com.
Our data is
marginally different since we have taken August data till 25^{th}
August, whereas the writer of the article might have taken slightly old data.
However, this difference is so small that it may be ignored. (According to the
article referred, Sensex was up 5.75 times over 20 years, whereas in our
analysis, Sensex is up 5.76 times). Investment in PPF, on the other hand, would
have multiplied by 7.31 times – quite a difference this is.
According to the
said article, investment of Rs. 10,000 in PPF would be worth Rs. 73,124. In
comparison, investment in Sensex for the same amount would be worth Rs. 57,520.
As mentioned
earlier, this number is calculated without adding back the dividends. What
happens if we add back the dividends?
Here is the data
(as calculated by us):
Amount invested:
Rs. 10,000 (one time investment)
Investment
period: 20 years
Value after 20
years:
Investment
vehicle

Value
after 20 years

CAGR


PPF

Rs. 73,124

10.45% p.a.


Sensex

Without dividends

Rs. 57,633

9.15% p.a.

Dividend yield of 1% p.a.

Rs. 70,387

10.24% p.a.


Dividend yield of 1.5%
p.a.

Rs. 77,841

10.79% p.a.


Dividend yield of 2% p.a.

Rs. 85,949

11.35% p.a.

Over the years,
the average dividend yield on Sensex stocks has been in the range of 1.5% p.a.
to 2% p.a. In both these situations, the final value of equity investment is
higher than PPF.
Having said that,
our attempt is not to prove that equity would always outperform PPF for periods
as long as 20 years, since we have also presented only one data point. The idea
is not to prove equity as superior to anything else, but to highlight the fact
that if some part of the data is ignored, a totally different picture may
emerge. Equity is a risky asset class and hence one should not expect 100%
guarantee of positive returns, whatever the period.
Let us revisit the title, "PPF investment can beat Sensex returns over 20year period"  can it happen? Yes, as mentioned in the previous paragraph, equity is a risky investment avenue. The risk may result into underperformance or negative returns. However, in this analysis, it did not happen.
Very good analysis and very valid points Amit!
ReplyDeleteThanks Suresh
DeleteThanks sir.
ReplyDeleteI feel even MF should use total return index as benchmark for large & diversified funds
I agree.
DeleteMoreover, the figures shown in the calculation were absolutely wrong. I have that calculation. Moreover, PPF was yielding 12% at the starting period of the sample which I thing is never going to be the case now. And of course I agree to other points that you have made sir.
ReplyDeleteThank you
DeleteHi
ReplyDeleteAs ET uses the convenience of not taking dividends you have taken the liberty of not taking brokerage costs given that composition of Sensex is dynamic and changes very quickly. Example RCOM was 34% in 2007 and is no more part of it. ITC from 2 to 10% and now 8
The brokerage cost back then was 2.5% and the traded rates would be high of the day ;) ( ask an old timer how much slippage)
What i would suggest is find the best returns :) on a CAGR basis taking your cherry picking between 19922014. It comes to less than 1114% only
You will notice that stocks out of the Sensex actually give you the equity returns !
Cheers,
Nooresh
Hi Nooresh,
DeleteI think I need to clarify what I have done. There is no cherrypicking and there is no attempt to prove that Sensex would always be a better choice even compared to PPF or any of the active portfolios. The idea was only to highlight the mistakes the writer of the article had made in his analysis. I am reproducing one line of my blogpost for your ready reference: "Equity is a risky asset class and hence one should not expect 100% guarantee of positive returns, whatever the period"
While stocks have come in and gone out of Sensex, your example of ITC's weightage going up or down is simply a function of changes in MCap of ITC with respect to the other shares in the Sensex. You need not worry about buying or selling a stock on account of this change in weight.
I take your point that the brokerage costs must be added.
Cheers
Amit