UP or Down What's Your Strategy?

UP or Down What's Your Strategy?

When investing in a fund, should you park your money in a category that has been sailing high or should you be an opportunist and take a stake in one that has been underperforming by a huge count? This article highlights the salient aspects of both such practices and provides some useful tips

The market is currently witnessing one of the worst volatilities in more than a decade. The Sensex is swinging by 1,000 points effortlessly on a daily basis. And the direction seems to be downhill as of now. This has adversely impacted the net asset value (NAV) of equity mutual fund schemes, which are down in double-digits for the year till date March 16, 2020. International, energy and banking-dedicated equity funds are the worst hit. The best performing categories are also in the red. Pharmaceutical and thematic MNC funds that have fallen down by 4.74 per cent and 13.88 per cent respectively in the same period.

There are some funds among the international lot that have lost almost one-third of their value year-till-date (YTD). As such, many of us who thought they had missed the bus earlier might be thinking of getting on to it. Many opportunist investors may be weighing their options. The question is: should you buy funds that have slipped the most? Now that the NAV of the funds have seen such a sharp fall, does it make sense to invest in a fund that has nose-dived? Investors in general are not good at timing. Many of them ‘buy high and sell low’.

against the cardinal principal of investing that says ‘sell high and buy low’. To get an answer to the above question of whether it makes sense to invest in worst performing funds, we carried out a study of funds for the past 12 years. The study was conducted at two levels: first at the category level and second at the fund level. It has been seen that there is always a change in the category of winners and losers .

For example, in 2010, on an average, funds dedicated to the banking sector outperformed all other categories. Next year, in 2011, however, on an average they were the worst performers. Similarly, in 2012, the worst performing sector was funds dedicated to information technology. However, the following year this category was the best performer. This does not mean that the underperformer of this year will be an outperformer the next year. For example, funds dedicated to the pharmaceutical sector remained the worst performers for 2016 and 2017 and have failed to outperform till now.

Nevertheless, the beaten down sector can be a starting point to find the next winners. If you are thinking about purchasing a fund because its category in general is lagging as compared to most others, looking for funds that are doing relatively well within that category is a good place to start your search. That said, you shouldn’t necessarily exclude from your search those funds that are doing worse than their peers when the group is down. According to a study by Morningstar India, if investors buy one fund from each of the fund categories that have seen the biggest redemptions in percentage terms over the preceding year, these unpopular offerings outperform the S & P 500 more than 70 per cent of the time in the ensuing three years, and these unpopular fund groups beat the three most popular fund categories 90 per cent of the time.

Even in the Indian context we see that other than sectoral funds dedicated to infrastructure, all other categories of funds tend to outperform in a cycle. For example, in 2017, when the funds dedicated to small-cap and mid-cap stocks were in rage, large-cap-dedicated funds largely underperformed the market. However, investors who dared to buy Axis Bluechip Fund, one of the best performing funds in the large-cap category, were handsomely rewarded in the following two years. Therefore, you may want to invest in funds that are out of favour with sorry-looking returns when its style is not represented in your portfolio. When a fund’s style, sector or asset class is out of favour, it may provide you an opportunity to diversify your portfolio at an opportune time .

Opting for Best Performers Many investors cannot help but keep a close watch on the performance of funds. They keep a note of the NAV of the funds. If, for example, the NAV is up by 10 per cent in the last one month and 20 per cent in the last one quarter, there are investors who will give in to the temptation and buy one of these hot funds, chasing their attractive historic returns. Many investors believe that they have the uncanny ability to notice what’s hot before it’s ready to cool down. That is because they treat strong near-term returns as evidence that a fund is good. “Where there’s smoke, there’s fire,” they reason. In general, buying funds based purely on their past returns is not a good idea. This is because styles, market-caps, sectors and industries tend to move in and out of favour in the marketplace.

Some funds are bound to soar for short periods if that theme happens to be in the sweet spot. The best example is that of infrastructure funds that were the best performers during 2006-07, attracting major attention of various investors. Nevertheless, after the financial crisis of 2008, these lost all their charm and are still lagging in terms of performance compared to other sectoral funds. Similar was the situation of small-cap dedicated funds, whose NAV in 2017 alone moved up by more than 50 per cent while some funds saw their returns zooming up to 70 per cent. The emergence of domestic mutual funds as strong institutional investors gave an impression that they were going to be ‘hot’ for some time. In the following two years – 2018 and 2019 – they generated negative returns.

So what should an investor do with a hot fund? One of the best ways is to get away from funds that have a very short life. Instead of outperformance, look for funds that are consistent performers. These are funds that hardly make headlines in terms of returns and they don’t get nearly as much attention as their more volatile counterparts. What they do offer, however, is reliability and comfort. They make it easier for you to stay committed, and that often translates into good long-term returns. A fund that has constantly remained in the top two quartiles in its category can be considered as a consistent fund. There are few funds that will do that all the time. Buying a fund with consistent returns will also help you to remain committed to the fund for a longer duration.

Conclusion

A fund that has generated negative returns recently is not necessary a bad idea to buy. Similarly, a fund that has been making news in terms of performance not necessarily a good idea to buy. Before buying a fund you should check the consistency of the fund’s performance along with other aspects such as its styles, market-caps, sectors and industries that should suit your risk profile and financial needs. 

Rate this article:
No rating
Comments are only visible to subscribers.

DALAL STREET INVESTMENT JOURNAL - DEMOCRATIZING WEALTH CREATION

Principal Officer: Mr. Shashikant Singh,
Email: principalofficer@dsij.in
Tel: (+91)-20-66663800

Compliance Officer: Mr. Rajesh Padode
Email: complianceofficer@dsij.in
Tel: (+91)-20-66663800

Grievance Officer: Mr. Rajesh Padode
Email: service@dsij.in
Tel: (+91)-20-66663800

Corresponding SEBI regional/local office address- SEBI Bhavan BKC, Plot No.C4-A, 'G' Block, Bandra-Kurla Complex, Bandra (East), Mumbai - 400051, Maharashtra.
Tel: +91-22-26449000 / 40459000 | Fax : +91-22-26449019-22 / 40459019-22 | E-mail : sebi@sebi.gov.in | Toll Free Investor Helpline: 1800 22 7575 | SEBI SCORES | SMARTODR