Identifying the Right Mutual Fund in a Falling Market

There are many concerns in the minds of investors when it comes to investing in mutual fund. With the indices trading at all-time highs, investors are wondering whether the markets would start falling sharply from these levels or there would be a minor correction in the market. Recently, we saw the equity markets falling from the recent highs by 3-5 per cent. When it comes to investing in a mutual fund, investors are worried that, if they invest in a mutual fund scheme now at these all-time high levels, and after investing, if the markets witness further downfall, then what will happen to their investments? This is a concern for an existing MF investor as well, who would be wondering whether to exit from the existing MF scheme or to continue with the investment. So, let us understand what you as an investor must do in the falling markets if you have already invested in a MF or if you are about to enter one.

It is very important that an investor should have a financial plan and he must stick to his plan, notwithstanding changing market situation or fluctuations. Events may come and go, but having a long-term view is the way to go, unless the economy is moving in a negative direction. It is very difficult or rather impossible to predict whether the stock market is at its peak. Usually, investors sit on the fence to check whether the rally is for sure and when they invest, the rally is about to come to an end. This further increases the risk for an investor. 

What an investor must do when the markets are falling
1 Align your financial goals with equity MF investments : If you are saving for a financial goal, which is 5 years or more from now, then you must stay invested in the equity mutual funds. Of course, it is vital to review your mutual fund portfolio at least annually. Many studies show that equity as an asset class has generated higher inflation-adjusted returns over the long term. Even the volatility can be eased by holding equities over a longer period. According to a study, Indian equities (between 1991-2017) have never generated negative return in any 15 years and the average return has been 7.29%.

2 Don’t go for NFOs and closed-ended funds : The fund houses are smart enough to focus on closed-ended funds instead of open-ended funds, which investors can invest during the NFO (New Fund Offer) period. This locks the investors’ money for the tenure of the fund, unlike open-ended fund where investors can enter and exit any time. Many agents sell NFOs and closed-ended funds due to the lucrative commissions they earn form selling these funds. Therefore, you should avoid NFOs of closed-ended funds. 

3 Pick funds that have done well in bear markets as well : History repeats itself and therefore you should learn your lessons from it. Hence, it is very important to look at the funds that have performed well not just in the bull market but also in the bear market. Some of the funds that have performed better than their benchmarks and broader market even in the bear market are given in the table below. The table would shows you the top 10 funds that have performed well in 2011 when markets were falling and the performance of the same funds in the current financial year (2017-2018) when we are having a bull market.
As we can see from the table above, these funds are thematic in nature. These are mostly from the FMCG, international and healthcare sectors. These themes tend to perform better during the bear markets. The above funds have performed well in the falling market of 2011 and are also performing well in the current market scenario. One must invest in funds with this kind of performance. But while investing, one must assess one's risk profile and invest as per one's risk appetite. As most of the above funds are thematic, these funds should not form the core of your portfolio and allocation to these funds should only be tactical. It is to be noted that the above exercise is carried out without considering the recent mutual funds re-categorisation as directed by SEBI. 

4 Consistency matters more than point-to-point returns : The point-to-point returns or trailing returns may give you a false picture as these returns may be influenced by the fund performance in the past. These returns are highly influenced by the starting and ending points. Ideally, it is good to look at returns over discrete periods, that is, one-year returns should be compared with the returns of three-five years. The returns must be looked over the complete market cycle, that is, in bear as well as bull market. Most importantly, the constituents of the fund's portfolio should be carefully analysed to gauge future performance of the funds. 

5 Large-cap diversified funds can be a safe bet Investment in large-cap diversified funds can be a safe bet in the falling markets. Although in a bull market, the largecap funds may underperform the small and mid-cap funds, when the market is falling, the large-cap can provide a cushion as they are less volatile and provide stability to the overall portfolio. 

6 Avoid sectoral funds : A few thematic funds are likely to do better than others in any period. For instance, infrastructure funds did well during the market rally in 2007, but when the markets tanked, these funds were hit the most. It is wise to avoid investments in the sectoral funds, unless you are convinced about the prospects of that specific sector. Our analysis of 220 mutual fund schemes that are in existence since 2008 shows that there are only few themes such as consumption, healthcare and IT that play out even in bear markets, while rest of the themes fizzle out. 

7 Invest via SIP route : Investing through the SIP route can prove to be beneficial as you do not have to worry about the rise and fall in the market. This is because when the markets fall, you will be able to buy more units at the lower NAV, and when the markets rise, you will buy less units at the higher NAV. So, this way you will enjoy the benefit of rupee cost averaging. The markets have again resumed their upward journey after a brief fall. Nonetheless, you cannot predict the future trajectory of equity markets, hence investing cautiously keeping in mind the above points will help you to reap the fruits of your investment in the long run.