Why you should stay away from 'politically-linked' stocks

The P-75 index, a subset of BSE 500 stocks, has severely underperformed the broader market across time horizons

A study by Ambit Capital concludes that companies enjoying a political nexus seldom make handsome gains for investors.

It says if a fund manager is mandated to deliver returns over a short time frame, staying away from politically-linked stocks is a sure way to boost risk-adjusted returns.

Its P-75 index, a subset of BSE 500 stocks, conceptualised in 2009, comprises 75 companies whose core competitive advantage by its assessment is on account of 'political connectivity'.

"We have repeatedly used the index as a barometer for how much those in power in the country want to help certain corporates," state Ritika Mankar Mukherjee and Aditi Singh, authors of the report.

According to them, the P-75 index has severely underperformed the broader market across time horizons, whether a year, three years or five years.

"The spread between median returns for the BSE 500 and P-75 index is widest for the one-year horizon, at 19 percentage points," their report adds.

The other interesting point in the report is that the P-75 index entails materially higher risk than the broader market across these time horizons.

"The risk for a one-year investment horizon is four times more than the broader market," it warns.

Unlike the broader market, the P-75 index's volatility does not reduce linearly as the time horizon increases. Also, with that index suffering a higher risk compared to the broader market, it severely underperforms the latter on risk-adjusted returns as well.

Ambit's research says the spread between risk-adjusted returns for the BSE100 and P-75 index is widest for the five-year horizon, at 3.2 times.

Also, performance of P-75 across these three time horizons indicates stocks of politically-linked company have a materially lower probability of earning returns higher than the risk-free rate.

This is indicated by the equity returns distribution curve, measure of the probability of beating the risk-free rate of return over any time period.

Photograph: Danish Siddiqui/Reuters