Received the following question over email today from one of our early investors. It is a very topical question - one that many might be wondering about - hence sharing it and my reply.
Too many things happening in the markets this September but the ongoing IL&FS fiasco doesn't seem to end anytime soon.
I feel this will be India's Lehman Brothers mess in making. I won't ask market specific question but the whole thing has badly impacted mood of the investors.
How do you see that impact AMC's if they have any exposure in this company and ultimately long term performance of their various schemes?
A normal mutual fund investor like me feels our money is not safe anywhere.
Many people are talking nowadays "mutual fund sahi nahi hai! "
Is this concern valid?
There are a few debt funds that have a direct exposure to IL&FS's debt and they have already marked it down.
The bigger problem is that the liquidity issue being faced by IL&FS can cause a domino effect on both debt and equity markets since IL&FS is a sizeable company which is what we are seeing currently.
Lehman was different since it was leveraged almost 100:1 on the asset side (housing sector) which went kaput thereby destroying all the equity of the company. IL&FS is facing re-financing issues (i.e. liquidity issues and not asset side issues) which can be resolved by its lenders should they choose to do so. Not sure how it's going to play out though.
(This blog post does a good job of explaining the IL&FS situation in simple terms. Do read.)
However, let's assume the worst and think through this.
Did Lehman make US markets un-investable for all times to come? The US market is up 100% since the peak of 2007 in ~10 years (7% CAGR with inflation close to 0% i.e. 7% real returns = equivalent to 14% in India where inflation is 7%).
Long term growth of equity markets is related to the long term growth of the economy which I think everyone will agree is still intact for India. Then it is just a matter of trying to predict the short term and avoiding losses in the interim a.k.a market timing.
As equity investors, we earn our returns when we go through the pain of such losses.
I don't think one should invest in equity markets thinking that he will be able to side step the crashes in equity markets when the time comes (today it could be because of IL&FS, tomorrow it could be something else - there is always a reason).
Which finally brings the entire question to your actual Risk Profile.
Risk profile is not about how much risk you can take when you think market is going to go up. It is about how much risk you can take when you think the market is going to crash.
Always invest according to your risk profile.
I can't stress this enough.
Not sure if this is what you wanted to hear. But it's better to invest thinking there will be another Lehman and another 2008 (and another dot com and 2001 and ...) at some point (whether it is IL&FS or not is irrelevant) and you won't be able to see it coming.
Have a question regarding your investments? Feel free to write to me at firstname.lastname@example.org or leave a comment below. :)