Dealing With Loss-Making SIP
Investment through SIPs is considered one of the most convenient ways of investing in mutual funds and creating long-term wealth. It enforces disciplined investing among investors and helps them to benefit out of rupee cost averaging. Nonetheless, there are situations where SIPs might not be the ideal investment route. The article explains why
What is ‘synecdoche’? It refers to the practice of using a part of something that stands in for the whole thing. For example, ‘wheel’ is referred many times to represent car or automobile. Similarly, SIP is many times used by investors for investment in mutual funds. Although SIP is only one of the ways to invest in mutual fund schemes, it is inadvertently used to indicate investment in mutual funds.
If we check on the internet for the use of this word, we find that SIP is more extensively searched than ‘mutual fund investment’ or ‘mutual fund’ itself. The graph below shows the Google search trends in India for the last three years ending October 2020.
SIP Returns
When a word connotes so much about an asset, its return definitely will have a direct bearing on the attractiveness of the asset. The graph below shows the return distribution of SIPs in equity mutual funds over different periods. On an average, the SIP return in the last 3-5 year period has been around 6 per cent. If we exclude sectoral funds such as IT and pharmaceutical, the average returns will drop further.
The graph indicates that inflows slowed down in mutual funds as returns from SIPs started showing negative return. Besides, as the equity market started gaining, investors who had parked their funds 2017 witnessed some gain in their portfolio and hence started booking profits and exiting from the fund. October 2020 is the fourth consecutive month when we have seen net outflows from equity-dedicated mutual funds. For October the net outflow from the equity-dedicated funds was to the tune of Rs 2,724.95 crore. A monthly SIP inflow that was to the tune of Rs 8,641 crore in March 2020 slipped down to Rs 7,800 crore in October.
Dealing With Loss-Making SIP
The returns generated by equity-dedicated mutual funds are very much dependent on the equity market. Hence, if the market itself shows a sluggish return, your fund is also likely to follow the trend and may show subdued returns. In recent years there has been another phenomenon known as ‘polarisation’ that is impacting the returns of mutual fund schemes. We have seen that a handful of companies are pushing the frontline indices higher. For example, for the first six months of this financial year, IT, pharmaceutical and Reliance Industries contributed most of the gains in Nifty or Sensex. The rest of the companies, and especially banks, lagged behind.
Since mutual funds are more diversified in nature and have a regulatory restriction to a particular company, this underweight exposure to the company has also been a drag on returns given by most of the equity-dedicated funds in the last few years. The underperformance of the funds against the benchmark creates a lot of concern and raises several questions among investors. However, this should not be the sole criteria to sell or exit from a fund as it may do more harm and make a bad situation worse.
The ideal response to such a situation would be to understand why the funds or markets are performing badly. The equity market usually performs well over a long period. In the short term, in some instances the prices tend to go up and down. While you can lose money in mutual funds due to short-term market disturbances, if you look at the long term the instances of negative returns are drastically reduced. The following table shows the average returns of SIPs in different periods. It clearly shows that as the period of SIP increases, the returns also increase and become more stable, represented by a lower standard deviation in the returns of different funds.
After comparing with the overall market you should also check your mutual funds’ performance against other mutual funds or its peers to understand if only your fund is doing badly or it’s a general trend where all funds are generating similar returns. For example, after the steep rise witnessed in the year 2017, the broader market-based funds (small-cap and mid-cap) have hugely underperformed the frontline indices. At one point of time in the year 2019, almost 70 per cent of the funds from this category were generating negative returns. Such a performance was not due to the bad quality of the funds but due to a larger market correction that impacted the performance.
As the market recovers, returns will again come back to the long-term average. Besides, when there is a deep correction in the market, it gives a longterm investor a good opportunity to buy more units of their MF schemes.
Reasons to Avoid SIP
Investment through SIPs is considered one of the most convenient ways of investing in mutual funds and creating long-term wealth. It enforces disciplined investing among investors and helps them to benefit out of rupee cost averaging. Nonetheless, there are situations where SIPs might not be the ideal investment route. When you are nearing your goal, SIPs in equity funds are most useful to meet your long-term goals like planning for retirement or saving for your child’s education. Nevertheless, when your goal is 2-3 years away, you should stop investing in SIPs and move your accumulated investments to funds that are less prone to market moods and offer lower but stable returns.
When you do not have a surplus to invest, SIPs require a regular monthly commitment. So if you are in a financial situation where you have little or no surplus to invest, you should stop your SIPs. If you still carry on with the SIP investment and are unable to meet your regular expenses, then it may put you in undue financial stress. When the fund performs badly, SIPs make investing easy, but the performance of funds should be periodically monitored. If a fund is constantly underperforming the benchmark, for more than four or five quarters, you should consider stopping your SIPs in that fund.
As the market recovers, returns will again come back to the long-term average. Besides, when there is a deep correction in the market, it gives a long-term investor a good opportunity to buy more units of their MF schemes. Hence, instead of stopping your regular contribution to your schemes while the market is in the mode of a sharp correction, you can do better by increasing the contribution. You should not increase your investment into your schemes if the fund continues to underperform consistently as compared to both peers and the benchmark. In such cases, you should redeem MF units from such funds and invest in better performing funds.
To arrive at the decision of how the fund is performing against its peers and the benchmark, you should compare the funds’ performances with their peer funds and the benchmark indices every quarter and if it continues for a year you should consider exiting the fund. One should not be impulsive with investment, especially with regard to equity as it tends to be more volatile in the short term. Therefore, you should not try to chase returns or aim to make the most of the market fall. It is always recommended to stick to your asset allocation based on your risk profile and take investment decisions accordingly.