Equities are the real gold over long term

By Prashant Jain
Einstein said, “Compound interest is the eighth wonder of the world. He, who understands it, earns it ... he who doesn’t... pays it”.
This has been experienced in India. At 17.1% CAGR, Rs 10,000 has become ~290 times in 36 years, while in gold at 10.4% CAGR, it has become ~35 times.
A difference of ~7% in returns over longer term (36 years) has resulted in 8x increase in wealth.
The average inflation over this period has been ~8% (CPI). Thus, gold has given returns that are close to inflation, thereby merely preserving the purchasing power. On the other hand, sensex has delivered nearly 9% excess returns over inflation. Over long periods, this has made a big difference.
The reason for this is simple. Equities over time grow in line with the growth of underlying businesses. As businesses comprise the economy, the nominal growth of the economy (real growth plus inflation) is a good proxy for the average growth in businesses. The table gives the nominal growth rates of Indian economy over last 35 years.
The Indian economy has grown at a remarkably constant nominal growth of 15% per annum. No wonder that the sensex CAGR of 17.1% is close to 15% nominal GDP growth.
Who is smarter: FIIs or local investors?
In India, it is interesting to note that in the last 22 years or so that FII have been allowed to invest in stocks in India, the FII ownership has gone up from nil to 24% — roughly 1% per year. The sellers obviously have been domestic investors.
The dollars received by the locals from sale of their shares have been thus invested in gold. Gold, as pointed out earlier, has yielded near inflation (~10%) CAGR vs 17% CAGR for the sensex. In effects, domestic investors have been exchanging a ~17% CAGR asset for a ~10% CAGR one. This certainly is not a smart thing to do.
The way forward
Outlook for Indian economy and Indian equities is promising. India is one of the best placed among large economies in the world in terms of demographics, demand, growth. India is a key beneficiary of lower oil prices. The savings from lower oil prices are near 2% of GDP on run rate basis at current prices over CY13 average.
Apart from lower oil prices, a strong, growth-oriented government bodes well for economic growth and for businesses. Key decisions of new government so far give confidence that lower fiscal deficit is a priority and it should continue to fall. Equities are the real gold. Equities compound near nominal GDP growth rates whereas gold compounds near inflation.
The writer is ED & CIO, HDFC Mutual fund