Is Equity Investing an Art or a Science?
Like countless other domains, equity investing has not escaped this debate of ‘Art or Science’. However, we would be barking up the wrong tree by trying to classify equity investing as either an Art or a Science. Equity Investing is not solely science or art. It is both. Application of quantitative research, financial models etc. gives investing a truly scientific flavour. However, use of financial models in investing is similar to that of navigation tools in driving a car. They may tell you the suggested route from Point A to Point B, however, they may not reveal critical information about quality of road, accidents along the route, difficulty of terrain etc.
The art is in using one’s prudent judgement, intuition, common sense and experience in assimilating information and making informed decisions. The role of emotions in finance brings into play the artsy nature of equity investing.
A case in point is the variability of SENSEX returns over the last 4 decades. SENSEX has grown ~ 311 times at a CAGR of ~ 15% during this period. This growth is hardly surprising considering that it has been in line with India’s Nominal GDP Growth of ~ 14% during the period. The scientific aspect of investing would justify this growth of SENSEX in line with the economic growth. However, given the volatile nature of equities, there were only few years over this period where the returns were close to the CAGR of 15%.
Variability of short term equity returns resembles the oscillation of a pendulum from one extreme to the other. Fiscal year returns of SENSEX (since 1979) have ranged from loss of ~ 47% to gain of ~ 267%. In 27 out of 40 years, returns were positive, while in 13 years, SENSEX yielded negative returns with 8 years witnessing losses in excess of 10%. Investors could have earned returns significantly higher than CAGR of 15% by staying invested & investing more during such market downturns. However, most investors exhibit various behavioural biases and end up buying high and selling low.
This unpredictable nature of markets brings into play the art of equity investing where investor’s judgement, patience, discipline and ability to tide over behavioural biases and paranoia are as important as economic fundamentals and research in determining his wealth creation potential.
The “Science” of investing suggests the proposed roadmap to your financial goals and the “Art“of investing deals with how you can go about it. While the Art vs. Science argument may not die down soon, an investor looking for long term wealth creation would do well to approach equity investing as a combination of Art (Behavioural finance) and Science (Economic fundamentals) without ignoring either.
“There is an art to science, and a science to art: the two are not enemies, but different aspects of the whole” - Isaac Asimov, American writer
This article has been written by Mr. Ashok T Kanawala, Vice President - Products & Business Development, HDFC Asset Management Co. Ltd.
The views expressed are author’s own views and not necessarily those of HDFC Asset Management Company Limited (HDFC AMC). The views are not an investment advice. Investors should obtain their own independent advice before taking a decision to invest in any securities.
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