Should You Invest Or Exit At An All-Time High?
Historically, markets being at all-time highs have generally not given any actionable decision on investments to the investors. In order to understand whether all-time highs provide any actionable indication to investors, we carried out a study. Here are the results
The first quarter of 2020 will go down in history as one of the worst quarters for equity investors. The corona virus that was limited to a single country soon started spreading around the globe and got promoted from being an outbreak to a pandemic. Countries were closing down in order to avoid any further spread. This had a huge impact on the economy and surely on the stock markets too. The pandemic led our key domestic indices such as S & P BSE Sensex to plunge around 38.88 per cent and earned the cadre of being a ‘black swan’ event.
In fact, such a fall happened in just a matter of two months. Not just the indices, but even the mutual funds that benchmark against such indices drowned too. Some of the funds lost half of their value in just a matter of two months. The banking sector funds were the worst hit and most of the funds either representing this sector or having higher weightage remained the worst performers.
Many market pundits predicted that the markets (Nifty 50) would even touch the 6,000 level, which would mean 50 per cent drop from its recent high. But none of such predictions proved true. The market started recovering from the lows made in March 2020 and exhibited a furious move to break out from its previous all-time high to create a new one. With this rising trend, investors started experiencing the ‘fear of missing out’ (FOMO) and started to invest more in this rising market. This further helped the market to gain and thereby boosted the returns. In fact, from the lows of March 23, 2020 many funds saw their net asset value (NAV) doubling.
The fall and rise in the NAV of mutual funds has made many investors wary who are in a dilemma about whether to book profit made from the funds or continue and enjoy the furious pace of the bull market. We will try to find an answer to this question by analysing the S & P BSE Sensex, which is considered as the barometer of the markets, and assume that fund performance will move in the same direction. So, let us look at the run it has had since the start of the leg of the bull market.
As can be seen, S & P BSE Sensex started its bull run at the end of March 2020 itself and broke its previous all-time high to create a new one in a matter of nine months.
It grew almost 72.48 per cent, which is a massive rise from a fall of around 38 per cent from its previous all-time high. Not just those, even the most laggard categories of last couple of years such as mid-caps and small-caps have shown a spectacular recovery. In fact, mid-caps generated 74.9 per cent returns and small-caps generated a whopping 92.82 per cent returns in the same period.
But there is a big difference in the recovery of large-caps and that of mid-caps and small-caps. In case of S & P BSE Sensex, it has crossed its previous all-time high, but in case of S & P BSE Mid-Cap index and S & P BSE Small-Cap index they are still away from the previous all-time high levels that were formed in January 2018. In fact, small-caps are still way behind their previous all-time highs. Therefore, you can see large-caps slowing down and mid-caps and small-caps outperforming large-caps in the last couple of months. When the markets are trading at their all-time high levels, there is a fear factor among investors who consider booking profits and moving to some conservative investments.
It is also evident from the recent action of investors. When the markets started moving up, post the recent fall in the month of March 2020, they started booking profit. This is reflected in the following graph.
In the graph above, we have plotted the values of the S & P BSE Sensex at the end of each month along with the net inflows of large-cap funds. As can be observed, as the markets started moving up, investors started booking profits, thus creating net outflow. This is in contrast to what a smart investor does. The graph below shows the activity of foreign institutional investors (FIIs) and domestic institutional investors (DIIs) in the same period.
It is seen that when the S & P BSE Sensex was moving up, this could be attributed to the buying done by the FIIs. In fact, DIIs were the net sellers not because they do not believe in the Indian story but this net selling can be accredited to the redemptions done by investors actually booking profits.
Investing in an All-Time High Market
Historically, markets being at all-time highs have generally not given any actionable decision on investments to the investors. In order to understand whether all-time high provides any actionable indication to investors, we carried out a study. In this study we took 20-year price data of S & P BSE Sensex from December 2000 to November 2020. For our study, we compared all the previous daily closing of Sensex with current or today’s closing. If the current day’s close was higher than all the preceding closes, then we calculated the one-year return from today. We have done this in order to understand if the index has made an all-time high what has been in next one year return.
Post this, we counted number of positive one-year return instances. We compared the same with that of simple one-year rolling returns. This comparison shows us how investing at all-time high stands as against investing at any level.
As can be seen from the above graph, 78 per cent of the times S & P BSE Sensex gave positive returns post making all-time high. While in normal one-year rolling return, 74 per cent of the times Sensex gave positive returns.
We even carried out the same study on large-cap mutual funds to understand how they perform when the markets touch new all-time highs. In the study, we found that there is no direct correlation between the markets making all-time highs and large-cap funds yielding higher returns in the next one-year, three-year and five-year period. Therefore, even while investing in mutual funds, don’t wait for all-time highs to invest. Rather, invest whenever cash flows are available since in the long term this would indeed reward you. In fact, the data shows that it does not matter when you enter the market but for how long you remain in the market.
The above tables clearly show that there is hardly any difference between investing at an all-time high and investing at any levels. Therefore, here we can say that all-time high as information suggests nothing and it makes no sense to base your decision on it. That said, it does indicate one thing – that for most of the times you invest at all-time highs, the returns would be positive, although there have been instances of negative returns too. The worst one-year return post making an all-time high was during 2008, when it gave negative returns of 55.18 per cent. Therefore, all-time high is certainly not a warranty of the continuation of a bull or bear run.
Timing the Exit
Investors in mutual funds face a host of problems due to not being able to determine the entry and exit points. If entry and exit points are known before investing, then you already have a plan of when to enter and when to exit. In the following paragraphs, we would understand when to exit from your mutual fund investments.
Performance of Funds
If you see a fund that is consistently underperforming in its category or even its benchmark, then this is definitely a sign of alarm. But in such cases you should not exit your investments just because of its short-term underperformance. Even the best of funds with decades of outperformance face temporary setbacks. Remember, if the fund is consistently underperforming its category and benchmark for 10 recent rolling quarters, and your financial goal is near-term, then exit from such a fund as you cannot afford to wait for its revival.
However, if your financial goal is long-term then you can wait for the fund (if it has a good long-term performance) to recover. You may use DSIJ’s mutual fund ranking to assess the fund’s short-term expected performance. In order to do so, you may look up your fund in our MF data bank at the end of our MF section in the magazine. Also, you can check the same on our website in the mutual funds section.
Change in Fundamental Attribute(s)
You should consider exiting a fund whose fundamental attribute(s) have changed. The fundamental attribute can be anything from a change in the name of the fund to a change in the way the fund is managed. For instance, let us assume you have invested in a multi-cap fund but the fund house has now decided to operate as a mid-cap fund. Consider exiting from the scheme if you do not wish have additional risk loaded to your investments. Likewise, for debt funds, a change in fundamental attributes can be such that a medium duration fund converts itself to be a credit risk fund by investing more in lower-rated securities, which may signal an exit.
Change in Fund Manager
Fund houses pitch a lot about their process-driven approach and how there is no correlation between the change in fund manager with the performance of the fund. However, we believe that fund managers do have a decisive impact on the performance of the fund. If there is a change in the fund manager of the fund you are invested in, though it doesn’t warrant an immediate exit, you certainly should cautiously monitor the fund.
Mergers and Acquisitions
The asset management companies (AMCs) have their own investment culture and processes that get reflected in their stock picks. However, if a fund house gets acquired by another one, then it is likely that its investment philosophy gets impacted. Again, it doesn’t signify you to exit in hurry, but definitely suggests you to follow significant developments in how the fund is being managed.
Overlapping Holdings
Let us assume that you have invested in two funds from different categories. While investing, you had minimum stocks that were overlapping. However, after remaining invested in those funds for some time, you may realise that these two funds now hold the same stocks. This overlapping would block your way towards optimum diversification. Therefore, you may consider exiting from one of the funds. Even holding too many funds would lead you towards over-diversification.
Hence, if that’s the case then consider reducing your list of invested funds. It is enough to have around eight well-picked mix of funds in a portfolio that invests in equity, debt and gold in order to attain diversification. And anything more than this would increase the complexity of your portfolio without accruing any benefit.
Financial Goals
Financial goals are one of the most important things to consider before exiting any fund. Consider that you had invested for a goal that was 10 years away at the time when you invested. However, now if it is three years away, then it makes complete sense to move out of risky investments to safe investments. This will ensure protection of your capital.
Rebalancing
Asset allocation strategies don’t work if you are not periodically (usually annually) rebalancing your investment portfolio. When you rebalance your portfolio, you would be booking profit from the one asset class and investing in the other. Therefore, to do so you need to sell some of the units from one asset class in order to buy in the other. This is also the time when you may consider exiting from some or all your units.
❝The average investor's return is significantly lower than market indices, primarily due to market timing❞
-Daniel Kahneman Conclusion
There is a famous quote that when everyone is greedy, be fearful, and vice versa. That said, this statement is quite subjective as everyone has his or her own way of gauging fear and greed. But most likely when the markets are witnessing a furious bull run and making all-time highs, people usually get a little fearful. Even the mutual funds’ net inflows data and FII and DII activity reflects this emotional streak. However, to understand the same we carried out a study and our study clearly shows that all-time high data doesn’t show any useful information in order to take a decision to exit.
Our study shows that, historically, if invested at all-time highs, in the next one year 78 per cent of the observations were positive, whereas if invested at any levels, 74 per cent of the observations stood positive. In the year 2008 when the markets were at an all-time high, the next one-year returns were negative 55 per cent. Hence, it is quite difficult to have a decisive conclusion. In conclusion, it makes complete sense to follow your financial goals and strategic asset allocation and rebalancing strategy since such a strategy would ensure that you get optimal returns for low risk in the long term.
However, for short term it is recommended to stay away from highly volatile investments. In the short term, aim at capital protection. Further, we have also listed down when you should consider exiting funds. This list would ensure that you don’t abruptly exit from funds just because you have a news channel telling you something about the markets. In fact, before investing you should know when you are planning to exit. This can help you to be disciplined with your investments.