In this blog we present our summary of the second video in the series where Equity risk premium has been discussed. (Emphasis Ours. The screenshots have been taken from the presentation given by Rajeev Thakkar).
What is Equity Risk Premium?
- Compensation for the investor for taking additional risk
- If market return is 10% and risk-free rate is 6 %, 4% is ERP
How much ERP?
- Varies for country to country
- Varies from time to time
- Broad Range 1.4% to 6.6% per annum
ERP in India
3.7% as calculated by Prof. JR Verma of IIM. To get the 3.7% return there is a lot of volatility! Equity investing is not suitable for short term investors.
As seen in below table the odds of Market return > risk free rate is far more in a 20-year horizon then a 1-year horizon.
- Don’t invest for short/medium term
-Don’t go all in at peaks
- Closer to the goal, shift money to low Fixed Income investments with adequate time remaining because of the volatility of equities.
To remove the volatility
- Potential structures to reduce/remove the downside like Attraction of HNI’s towards Index linked debentures
- They may reduce the upside or transform the payoff profile
Not factors in themselves: they support the main factors like size, momentum, value, beta etc.
If your remove the small junkies, size factor work nicely, size + quality will do wonders. Quality is not only relevant to size but all factors.
Avoid bad quality
- Outright Frauds
- Earnings Manipulation
- Bankruptcy risk
Buy Good Quality
- High ROCE
- R&D, growth Marketing
- Buyback Open offer
- Insider Buying/Selling
- Smart Investors cloning
- Hostile takeover – might give cost efficiency, unprofitable units will be sold out