This is a wrong headline, let me start by making a confession. I was doing ‘equity valuation’ – a sexy topic always for students and even budding fund managers. The purpose of doing this article was that I was suggesting to the class that valuation always starts with the bond valuation – and then you price risk and arrive at the price of equity. What would happen if you thought of equity just as a bond with a long – maybe very long – very high quality bond. After all one day you will sell your shares, will you not? A client who died recently bequeathed his portfolio on his heirs – and it included shares bought in 1970. One of the inheritors is his 19 year old grandson who got 3500 shares of Colgate – and that kid says he will give it to his grandson. Of course Colgate was an IPO acquisition and this man never sold it. He did not of course treat it as a zcb (zero coupon bond). If he had treated it as a zcb he would have had to buy MORE shares every year from the dividend. Thats a long story, but yes, you can treat an equity share like a bond.

Bonds are fairly simple instruments. In general, you know what a  bond’s return will be and you know what its time horizon is. Of course the assumption is that it is so high quality that there is no default risk, and it is a buy and hold portfolio. These 2 assumptions mean that you do not worry about day to day prices. This makes investing in fixed income instruments  simpler than investing in shares. In the equity purchase you have no time horizon, and there is pressure from the media to trade. The  difficult part about the share market is that you do not know the future returns (rising dividends?) nor do you know the time horizon for which you invested. This uncertainty makes the share market unnerving, scary, and almost disruptive to good long term wealth creation strategies.

This distinction between “shares”, “mutual fund portfolios”, and “bonds” can be reduced. All investments – including the rental real estate (own residence is too emotional, and does not really fit in an excel sheet). Terms like “money”, “cash” “bonds”, “terminal value” are designed to create confusion so that we can charge the client a higher fee for complicating things. I like to think of all of these instruments simply as varying types of financial instruments with some similar characteristics. Trying to put them in buckets is useful for the portfolio manager and not so much for the students.

Can we really make the share market returns more predictable? Well yes, consider the equity / portfolio as a ‘bucket’ with a duration of say 15 years. Yes some of the components would change if you consider the mutual fund portfolio, but for us that should not matter. Use the Growth option (so reinvesting is avoided) or if you are considering a single share, you must ignore transaction cost, but assume that the dividends got reinvested to the nearest share. Unfortunately in RE the rent will have to be reinvested in a 10 year G sec or arrive at the IRR and assume that the rent got reinvested at the same rate.

Oops, have I confused you enough? We will save more gyaan for another day.