3 Fund Categories To Buy Now

Every market condition creates its own winners and losers. DSIJ takes you through three categories of funds that you can invest in the current volatile market.

If you torture the data long enough, it will confess to anything, said Ronald Harry Coase, a British economist and Nobel laureate. The data released by Association of Mutual Funds of India (AMFI) for the month of September 2018 is also being tortured by many to make a sense that suits them. The data for inflows of funds to equity-dedicated mutual funds in the month of September hides more than what it reveals. It shows that inflows to the equity funds have improved in the month of September. According to the data, the total inflows into equity funds for the month of September 2018 stood at Rs. 11251 crore, including arbitrage funds and ELSS. It is the highest net inflow received in the last four months. This is against the background of the equity benchmark index Sensex falling by almost 11 per cent. Nevertheless, what it hides is that such figure is achieved not by higher inflows, but due to lower redemptions. The sales of equity schemes declined by 3.1% on a sequential basis to Rs. 27400 crore, while redemptions fell sharply by 27.8% during the same period to Rs. 16100 crore.



The same happened to Systematic Investment Plans (SIPs) which, according to the data, showed continued growth. SIPs were up for yet another month and for the month ending September 2018, SIPs amounted to Rs. 7727 crore. This figure is higher by 40% on a yearly basis. What it did not tell is that the pace of growth in fresh SIPs has slowed down over the last three months as the SIP book grew by a little over 2 per cent during this period. More than that, the number of SIP accounts closed during last month is also very high. 

Some among you may also argue that we have also been torturing the data to extract a different meaning. However, our understanding corroborates with what is happening in the market and is in sync with investors' behaviour in these times. 

The Change In Mood
All the above figures clearly point to the fact that the recent volatility in the equity markets is taking its toll on MF inflows too. The euphoria of investing through mutual funds that started sometime in year 2014 is showing the first signs of exhaustion. The AUMs of the industry have got stuck around Rs. 22 lakh crore in the last one year, although in-between, the AUMs touched Rs. 25.2 lakh crore. However, now the AUMs are again at Rs. 22 lakh crore. Earlier this year in the month of February too, we saw that the AUMs of the industry declined for a while, but the fall seems to be steeper this time.

For someone who started investing in 2014 or after that, this might be his first face-to-face encounter with volatility in his short span of investing. The last few months of market fall hit their gains and hence they were less perturbed, but their patience will be checked once this volatility starts impacting their capital and they find erosion in the principal amount invested. 

Our analysis of all the open-ended equity funds show that till the end of August 2018, all the categories of funds were giving positive SIP returns for one year ending August 2018. The return for the three years was in double digit. Nonetheless, the entire picture has changed in the last one-and-half months. The table below clearly shows that the returns of SIPs of all categories in the last one year on an average are negative now. Hence, someone who had started SIP in the last one year might be witnessing a negative return on his investment. This is on the assumption that all the investments are done at the start of the month. However, the three-year returns are still positive. However, these are in single digit and another bad month like September in all likelihood is going to make even three-year returns negative.



If we look at the entire universe, there are only three sectors that have given positive return in the last one year and these are IT, pharmaceutical and international.

This is a scary situation for many investors and many of them are thinking of stopping their SIPs, which is reflected in the number of SIPs stopped last month. It is more in the case of investors who had invested in mid-cap and small-cap funds that were generating phenomenal alpha in the last few years. Nonetheless, in the last one year, these funds have lost their mojo.

What does this mean for an investor? Should you stop your investment now and wait till the market improves or should you now become receptive to investment ideas. We believe you should not stop your investments now. To understand why, let me take you through how the equity market behaves and why it makes sense to remain invested and continue your investment.

What does the future hold?
The frontline indices in the last one month are down by around 8 per cent, while the broader indices such as mid-cap and small-cap are down by even more. These indices have fallen by more than 20 per cent. This means that these indices are already in a bear phase, at least technically. This has already resulted in the moderation in lump sum investments. 

Before taking any decision on your investments, you should understand that the markets are cyclical in nature and they go up and down in cycles. When the macroeconomic parameters of the economy are showing healthy signs of growth, mid-sized and small-sized companies tend to do better. This gets reflected in the performance of their share prices. They tend to do better than their large-cap counterparts. This is clearly showing in the movement of their respective indices. You can clearly see in the graph that as the macros of the economy in terms of external debt, inflation, IIP were all improving few years back, small-cap and mid-cap indices moved faster than the Sensex, representing the large-caps.

Now, in the last few months, as the macroeconomic factors of the country started weakening, which is being reflected in the falling external value of Indian rupee, higher crude oil prices and its impact on current account deficit, inflation and higher interest rates. These are impacting the performance of the mid-cap and small-cap indices. The mid-cap and small-cap companies have been the worst performers in the last few months. 

Going ahead, we see that the uncertainty will continue in the Indian economy for reasons such as geopolitical tension and valuations being still higher as compared to the long term average. Hence, investors will have to put up with volatility for some time now. 

What an investor should do
Against this background, it becomes clear that the investment ride from hereon is not going to be as smooth as it was few years ago. Hence, the changing times require change in your investment strategy. Remaining in cash might seem to be the most sensible strategy for many investors, but it will be like timing the market, which even the most seasoned investor can rarely do. Hence you should remain invested. As the markets are volatile with negative bias, you should sync your investment strategy accordingly. We believe that the following strategy would help you to ride the volatility in a smoother way.
 

Invest in schemes that have performed well across the market cycle
Currently, there are around 380 primary equity-oriented open-ended mutual funds. Out of which, approximately 260 funds have completed 10 years. In the last 10 years, we have gone through three such periods when the benchmark equity indices have declined by 20% or more which, in other words, was a bear phase. A fund that has performed well in bull market may not perform well in the bear market. This may be due to various reasons such as the mandate of the fund limits its ability to contain the fall in its net asset value (NAV) or the sheer inability of the fund manager to steer his funds in such difficult times.

Therefore, investing in funds that have done well during both bull and bear phases may be an appropriate idea in the current times. Our analysis shows that, in general, many large-cap funds have performed better during this time. There are couple of small-cap funds too that have performed well in the last bear phase. Hence, it is no coincidence that even at the current juncture; the same funds are beating the performance of both their peers and the benchmarks. Some of the small-cap funds, such as Franklin India Smaller Companies and HDFC Small Cap Fund, have outperformed by a huge margin. In the large-cap dedicated funds, JM Large Cap Fund has been consistent in beating its benchmark and peers. Even some of the contra and value funds have performed better in these conditions. 

A special note needs to be mentioned about the sectoral funds. History has shown that every bull market creates its own winner. In other words, every bull cycle is led by a different sector. For example, during the 1992 bull phase, the cement companies led the rally. In 1999-2000, the IT companies were winners. Similarly, in 2003-07, infrastructure and real estate companies created the wealth for the investors.

Hence, the next bull cycle will be led by different set of sectors and companies. In the current scenario too, we see nonbanking finance companies (NBFCs) have created huge value for their investors which, going forward, we doubt will create wealth for you. Hence, it is advisable to stay away from such funds that have heavy exposure to such sectors.

Invest in multi-cap funds
Another way to shield your investment from the current volatility is to invest in multi-cap funds. Various academic studies have shown that different categories of stocks perform differently in different periods. A common investor neither has the knack to understand these cycles nor does he have the time to analyse these cycles and shift his investments accordingly. Therefore, ideally a multi-cap equity fund that can invest in any of the market cap stocks, should give you better returns than any other category of equity funds. This is because the fund manager can shift his investments across sectors and categories. Multi-cap funds are 'go anywhere' funds that invest in companies across market capitalisation and sectors. Even the new categorisation rule by SEBI for multi-cap funds stipulates minimum investment of 65% in equity and equityrelated instruments of the total assets. Even in the current scenario in the last one month, on an average their performance has been better than the mid-cap, small-cap and some of the sectoral funds. Historically too, we have found these funds doing better than small-cap and mid-cap funds during the falling market. Even in the month of September, the multi-cap funds fell less than the small-cap and mid-cap funds. The multi-cap funds on an average fell by 10.91%, as compared to the fall of 13.78% and 12.87% of small-cap and mid-cap funds, respectively.



Invest in hybrid funds
One of the key reasons the participation of the Indian investors is still low in mutual funds is because of their bad experience in equity investment due to capital losses. Many of investors enter the equity market (either through direct equity or mutual fund) when it is at the peak and leave once the market starts falling. In the process, they take back a very poor equity investment experience. Such experience keeps them away from investment in equity or equity-related products. Therefore, it becomes important for all investors to overcome this behavioural investment trait of buying high and selling low.

One category of fund that helps investor to correct this investment trait is “hybrid funds”. Investment in hybrid funds that invest in both debt and equity may help investors to limit their capital losses and hence improve equity investment experience. In the last few months, these funds have performed better than pure equity funds. In the month of September, aggressive hybrid funds fell by 8.1% as compared to more than 10% by equity funds. Therefore, it makes sense to invest in hybrid funds that invests in both equity and debt. The graph below clearly shows how ‘aggressive hybrid’ funds have outperformed other equity funds in the last one and three months.

There are other compelling reasons why you should invest in hybrid funds, especially for someone who is entering for the first time in the investment arena. Historically, it has been proved that returns of a portfolio is determined more by the asset allocation rather than by individual stocks or bonds. Hybrid funds give you readymade solution to this problem with periodic re-balancing. Besides, the structure of the hybrid fund is such that it is tax-efficient, especially ‘aggressive hybrid funds’ that invest at least 65% of their corpus in equity. Therefore, these funds enjoy equity taxation benefits on both capital gains and dividends.

Do not stop your investments
It is better to be cautious at the current juncture as the market is still volatile and you do not know how the markets are going to behave going forward. Although the recent correction is healthy in nature as it clears much of the froth in the market, it is still not out of the woods. Various national and international factors will keep the markets volatile. Nonetheless, if you are a new investor, this correction should not worry you as it presents a good entry point.

However, if you are an existing investor, you should always remember why you have invested in the funds and should avoid stopping your SIPs. Stopping the SIP defeats the very purpose of starting it. that is, rupee cost averaging. Depending upon your risk appetite and investment horizon, you can choose any category of funds from those mentioned above and make your investment experience better. 

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