Trailing 5 Year, 3 Year and 1 Year returns are strong indicators of future returns.
As a thumb rule, other factors remaining constant, equity returns are commensurate with nominal GDP returns. In Indian context, nominal GDP growth is around 12-13% (@7% real GDP growth and @ 5% inflation). In the long run, equity returns are expected to converge around this level. Whenever, trailing returns diverge widely from 12-13% for a longish bit of time, the future returns fall/rise to bring the average returns back to that range.
As on December 2024, the headline index viz Nifty 50’s 5 Year, 3 Year and 1 Year returns were around 14%, 11% and 9% respectively. However, midcap index, Nifty MID100, and smallcap index, Nifty SML100, gave unsustainably high returns of around 27%, 23%, 24% and 26%, 18%, 24% respectively over the aforesaid time frames.
And in a déjà vu fashion, since the beginning of CY 2025 to today viz 25 Feb 2025, Nifty 50 has fallen only around 5% (despite continuous selling by FII’s which predominantly hold large caps), it is the Midcap and the Small Cap indices which have fallen 13% and 18% respectively.
Many investors whose portfolios were largely in mid and small caps committed a benchmarking mistake of looking at Nifty 50 trailing returns and became complacent/confident about continuation of similar trend in 2025 and beyond. The right indices to benchmark the portfolios were Midcap and Smallcap.
It has been a great learning experience on several fronts – about the correlation of equity returns to nominal GDP growth, choosing the right indices for benchmarking and how sometimes inadvertent cognitive mistakes happen. These lessons need to be remembered for all times to come.