Is It A Good Time To Invest In Mutual Funds?

The volatility in the equity market has deterred many investors from adding in fresh money into mutual funds. DSIJ explains, how and where to invest in these times

The year 2017 was a great year for equity investors. During the year, investors witnessed frontline indices touching life-time highs almost every month, with few exceptions. Such rise in equity prices generated tremendous returns for mutual fund investors who had stuck to equity funds. The impressive rise in the equity prices and indices attracted many investors to the equity funds. 

The skyrocketing equity market motivates the new and existing investors alike to invest in equity mutual funds. This is reflected in the rise in the assets under management (AUMs) of the domestic mutual fund industry. It has increased by 32.4 per cent in 2017. At the start of the year, the total AUMs stood at Rs 17.06 lakh crore, and by the end of 2017, it stood at Rs 22.6 lakh crore. The year of 2018 started off well, with the equity markets touching their life-time highs. Nevertheless, in the Union budget 2018, the Government of India reintroduced the long-term capital gain (LTCG) tax on equity investments, along with the dividend distribution tax (DDT) on mutual funds. These changes spooked the markets. What also played the spoilsport were the weak global cues along with the geopolitical tensions. 

This has made the markets volatile and the worst-hit were the small-cap and mid-cap stocks and their benchmark indices tumbled more than 10% year till date. Such a fall has curtailed the returns of the investors and created a worry in their minds about their own investments. There is also evidence which suggests that new investors are now opting for more traditional investment options such as fixed deposits due to the rising interest rate scenario. 

We feel this may be a knee-jerk reaction by the investors on account of the sudden fall in the equity markets. We believe that this is not a right time to dump your investments and let the volatile markets force you to take wrong investment decision. 

The history and what it teaches 

There is a direct correlation between inflows into the mutual fund schemes and equity market performance. As the equity market performs better, investors pour money into MFs, but when the markets turn volatile, investors at large usually stay away from the markets and refrain from putting in fresh money. We believe this is not the right approach to investing. These corrections are temporary phenomena and, in long run, markets always bounce back. This will be quite evident if we study what has happened in the past. For this, we have analysed the price movement of the benchmark indices of all large-cap, mid-cap and small-cap companies for the last 15 years. If we study the graph closely, we can see that there were two major corrections in the last 15 years. This also included one of the worst corrections that the markets have ever witnessed during January-2008 to Feb-2009. During that time, the benchmark indices BSE Sensex, BSE Mid-cap and S&P BSE Small-cap have witnessed fall of 56%, 72% and 77%, respectively, from their peaks. Despite such a major fall happening during the ensuing 14 months, these indices bounced back with a vengeance. These indices rebounded in just next three months and by May 2009, these indices had rallied almost of 64%, 83% and 93%, respectively. A similar trend was observed during the period between Feb 2015 and May 2016 where these indices fell by 22%,11% and 15%, respectively, only to rebound by May 2016 in just two months. This is the reason why it is always advisable to stay invested during the downturn as investment during the downturn will benefit more in the longer term. 

Should you time the market? 

For investors who try to time the market, the fundamental analysis of the indices suggests that the valuation of the mid-cap and small-cap indices are still higher compared to their longterm average. The reason for such high valuation is because we have not seen any meaningful correction in the markets in the last couple of years and the earnings have not caught up with the rise in stock prices. With the current valuations, we can still expect some correction, at least in the mid-cap and small-cap stocks and funds investing in these stocks . These corrections are necessary and healthy to prevent building up of a bubble. Therefore, these investors can wait on the sidelines for the right opportunity to invest in small cap and mid cap funds. We, however, always recommend remaining invested. 

Remain Invested 

We still see the equity fund as an attractive investment avenue. The primary reason behind this is the robust earnings growth. In the last quarter of FY2017-18, the key companies reported a great quarter on a yearly basis. The first quarter of FY19 also started on a good note. With the rising earnings growth, the equities are expected to do better and hence the current fall presents a perfect opportunity for averaging your investments. Although the valuations of mid-caps and small-caps are still a worry for the investors, it should not deter the long-term investors from entering these categories as well. So, in the case of investments in equity funds, if investors are willing to invest, they should go by the fundamentals of the companies. 

There would be no short term mutual fund picks currently. To make a long term commitment, investors need to deeply analyse the portfolios of the equity funds, especially the small-cap and mid-cap funds that still looks vulnerable. 

Right Asset Allocation Equity is not the only asset class where a mutual fund investor can put money. There are other options available for mutual fund investors. It has been established that a right asset allocation can lead to a better return in the long run. A person with a prudent asset allocation strategy as per market condition gets more returns even in unfavourable market conditions. So, understanding asset allocation and using it wisely in various market conditions is important for any mutual fund investor. Asset allocation is nothing but allocating funds into different asset classes with a view to safeguarding and optimising the returns. Debt funds remain one of the most important asset classes. Among the debt funds, some of the funds such as gilt funds have given negative returns in the last six months. Therefore, currently, when the interest rates are rising, an investor needs to stick to the short-term debt funds, which are likely to gain and have lower interest rate risk (for detail you can check our special report: Selecting The Right Debt Mutual Fund). In case of equity investments, he should allocate a fair portion of the equity investment into large-cap funds. 

Pockets of opportunity 

Considering the current market volatility, investors can still choose between various options available for investment. Our mutual fund industry gives many choices for investment, one just needs to evaluate them properly. Given below are some of the types of the funds which can be used in the current market condition. 

Value Funds 

These funds follow value investing strategy. For the long term investors, value funds are one of the best options currently available among the equity funds. These funds tend to invest in securities which are undervalued by the market. The portfolio of these funds is fundamentally strong and is expected to survive market downturns. We have seen that in the bull market in the last couple of years, many stocks have been overvalued which are currently witnessing a major downfall. In a volatile market, value-based investment strategy is expected to bode well for investors having a longer investment horizon. 

Dynamic asset allocation funds 

For investors who are looking for short term returns in shorter time horizon, dynamic asset allocation funds are currently good investment options. These funds adjust their asset allocation in the portfolio according to the market conditions and try to enhance the returns. These funds with the moderate time horizon can benefit the investors as well. By investing in these funds, investors don't need to rebalance their portfolio and adjust the allocation towards debt and equities. The fund managers of these funds do it for them 

Credit opportunities fund Investors who are looking for debt funds can now look for credit opportunities fund. These funds choose the lower rated bonds which are expected to perform better in the coming period. The conservative investors who are willing to invest in debt funds for the long term can choose these funds. 

Further, to ride the volatility, investors can choose the short duration bond funds, and even among the pure equity funds, investing currently in large cap-funds will be safer than investing in the small-cap and mid-cap funds.

Sector Funds 

There are some sectors that are showing signs of revival and investors can look at investing in them. According to our analysis, the pharma sector, which has taken a major beating in the last couple of years, is expected to heal the investors in this critical market downtrend. In addition to that, the IT sector is another sector which is expected to perform well in the coming period. 

One of the primary reasons behind the expected better performance of these sectors will be the rupee depreciation. On the other side, the improving financials of the companies are backing the growth of these sectors. Apart from these two sectors, the consumption story is expected to be in place to enrich the investors' returns. 

Harshad Borawake Head — Research & Co-Fund Manager Mirae Asset India Equity Fund

"Investing in multi-cap funds should be the core strategy of investors in current market situation"

How can investors benefit by investing in mutual funds now? What opportunities are available in the mutual fund arena in the current market conditions? We believe mutual funds offer investors a simple, transparent and efficient platform for investors to make their investments. Investors can accomplish various goals like wealth creation, regular income, etc. by investing in funds which suit their investment time horizon and risk appetite. Also, in addition to providing option of choosing great products (funds as they are called in MFs) which have a strong track record of outperforming the benchmark over various market cycles, MF industry provides facilities like SIP, STP and SWP to help investors make and redeem their investments systematically. MFs provide a vehicle which helps inculcate discipline in investing, and remove focus on market noises and index values. Since there is great push from the government to move from physical assets to financial assets, a lot of investors have been actively looking at MFs as their investment vehicle. In the current market scenario, we believe markets are expected to witness volatility and we believe investors should take SIP and STP routes to invest from debt to equity funds. 

What is the right asset allocation strategy given the rising interest rate and heightened volatility in the equity markets? There is no single asset allocation mix which is an appropriate response. We believe the right asset allocation is based on the investors risk appetite and investment time horizon. A number of studies have shown 90% of the investors' returns are based on asset allocation, while security selection and market timing are not that relevant over the long term, hence a good mix across equities, debt and physical assets will provide a better investment experience to investors. We believe the role of the advisor will become very important at this time, as there has been significant volatility in the debt and mid-caps and small-caps during this year and a lot of hand-holding is required to prepare an appropriate asset allocation strategy for investors. 

Under the current market conditions, which categories or sectors should investors focus on while investing in equity funds? We believe that in the current market conditions, multi-cap funds, which have the flexibility to switch allocation between large-caps and mid/small-caps and across sectors remain the most suitable equity category and should be the core strategy investors should look at. Investors with higher risk appetite can look at large and mid-cap funds (this is a new category which provides the fund manager flexibility to invest 35-65% in large-caps or mid-caps) as well. 

We remain very positive on the consumer theme (as we believe it is a multi-decade theme) and healthcare sector (a contrarian strategy, as this sector has corrected a lot in the past 2-3 years, but its long term outlook is very positive) and believe these are interesting tactical strategies which investors can look at. With the yield curve almost flat, the short term funds are the most attractive debt fund investing opportunity, as investors can take benefit of higher yields with lower maturity and interest rate risks. As the yields have gone up significantly over the last 6 months, we believe investors can look at liquid funds for parking their short term funds, instead of savings account of banks. 

With the huge volatility in the market, what would be your return outlook for various categories of mutual funds for the next couple of years? At the current juncture, investors should moderate their return expectations in the near term, as markets will not be able to replicate the performance of last year which was meaningfully higher. Over the longer period, any stock return is generally commensurate with the underlying earnings growth. In the long term, we believe equities can deliver 400-500 bps more and debt funds 100–150 bps more than the prevailing inflation rates. The well-managed funds in these categories can add an alpha of 2-4%, making investment returns attractive. We expect earnings growth to pick up, which will help equity markets to do well over 2-3 years. 

Post mutual fund categorisation and reclassification, how should investors evaluate the performance of mutual funds to select the right funds to invest in? As mentioned earlier, we believe investors need to consult their financial advisor and create an asset allocation strategy with mix of funds and asset classes based on the investors time horizon and risk appetite.

What will be your advice to both novice and mature investors in the current market conditions? We would advise to invest in a disciplined way in equities for the long-term, within the earmarked asset allocation. We believe that a larger portion should be allocated to the multicap funds. 

Conclusion 

Investor should always remember that while selecting a mutual fund scheme, past returns should not be the only parameter. After the categorisation and reclassification of the mutual fund schemes by SEBI, it is difficult to evaluate the performance of the fund going by its past returns due to the mergers and consolidations of many schemes. Therefore, the portfolio of the fund has become more important for the investors. We at DSIJ have introduced a unique ranking system of all the equity mutual funds that analyses the constituents of mutual fund and gives you the expected return over next one year. You can find the current ranking in our website http://www.dsij.in/mutual-fund 

At the current juncture, investing in mutual funds would be largely dependent on the risk appetite of the individual investor. If you are a high risk investor, you can invest in a lump sum, but if you are not, then the systematic approach would bode well for you. The volatility in the market will continue in the upcoming period, so one needs to make choices properly. In the end, investors should remember that getting panicky during market downtrends would lead to taking wrong decisions. So, staying invested in mutual funds would be a great decision for wealth creation. In the current environment, you can change your asset allocation pattern. Looking at the current environment, giving more weightage to large cap funds along with low duration and short term debt funds can help you to protect your returns. You should always invest in mutual funds with a proper strategy that helps you to achieve your financial goals and short term volatility should not force you to deviate from your plan..