Though most investors are aware of the fact that investing in stock markets should deliver better returns that fixed deposits, over time, there is a reluctance to invest a substantial portion of the total corpus in stock markets. One of the primary cause for this behaviour is the volatility in stock market investments.
For example, if you invest Rs 100 in a bank fixed deposit at the beginning of the year, you can be reasonably sure that it will become Rs 107 at the end of the year. On the other hand, if you invest Rs 100 in the stock market, based on long term averages, it should close the year at about Rs 112 – but that rarely happens. During the years, the Rs 100 invested is volatile and can be Rs 90 during the market lows or Rs 125 at highs, due to market volatility (approximate numbers to illustrate). Over time, stock markets should return 12% per annum, but the returns are volatile.
If there is no volatility in stock markets returns, investors are likely to deploy lot more of their savings in the stock markets – but that would never happen. Now for the good news - Volatility in Indian stock markets is reducing.
How do we know that volatility is going down
To measure volatility in stock markets, we looked at BSE Sensex data since 1991 (We choose BSE Sensex, as it has a longer history than the Nifty).
BSE Sensex Volatility since 1991
To measure volatility, we assume a simple formula: (High for that year/Low for that year) – 1. Based on historical evidence, volatility in stock market returns have been reducing over the past several years.
In 2018, we had several extraordinary events: Global trade war, sharp rise in oil prices, RBI governor quitting, uncertain political environment, midcap correction, etc. Despite all these, the Sensex volatility was significantly lower than what has been observed over long periods of time.
What’s causing this lowering of volatility?
Developed markets like US, Europe, Japan, etc see less volatility than the Indian stock markets. It should also be fair to assume as markets mature, there is a reduction in volatility.
One of the reasons for increased maturity is the variety of participants in the markets.
Today, Indian markets are seeing active participation, not just from global investors, but also from domestic institutions and individuals. From insurance companies to mutual funds to now even the EPFO, the Indian stock markets attract the interest as well as money of many institutions, big and small. This has meant that the markets are not excessively dependent on any one market participant. Moreover, with reduced inflation, lower interest rates, volatility tends to be lower. The regulator has also played an important role in creating a stable environment for investing.
It is difficult to say if the reduced volatility seen in the recent years is sustainable, but the current trajectory does point in that direction. Lower volatility is good for investors and we do believe this trend will continue.