Time To Buy Mutual Fund Aggressively
Historically, election years have been rewarding for the equity MF investors, so do not wait on the sidelines for the elections to get over, for you might miss the bus if you are not invested
The darkest hour is just before the dawn. The inflows into the equity MFs have touched their lowest in the last two years. The net inflows into equity mutual fund schemes, including ELSS, came in at Rs 5122 crore for the month of February 2019, which is down by 17% on a monthly basis and is at a two-year low. Last time, we saw such low inflows in March 2017. After that, there was spurt in inflows, which touched Rs 20362 crore in the month of August 2018.
This leads us to a question: Have we touched the low in terms of inflows and will we see a reversal in the trend and an increase in net inflows into equity mutual funds? Have we left the worst in terms of inflows behind us? To answer this question, we need to understand the factors that have led to such a decline in inflows and whether those factors are going to turn around now.
The reason for such low inflows is consistent underperformance of the MF schemes in terms of returns as compared to even bank fixed deposits in the last one year. Except for the large-cap category, almost all other categories in equity dedicated funds have given lower returns than bank fixed deposits (FDs), assuming an average FD rate of 7 per cent.
Such underperformance was reported despite the large surge in the performance of MF schemes we saw in the last one month. The picture of returns was much grimmer one month back (see the graph). The table below shows that, on an average, thee domestic equity funds have generated returns in the range of 7-11 per cent.
So what is the reason for such recent outperformance of the schemes and whether it will attract inflows from the retail investors into mutual fund schemes? Also, how sustainable is the outperformance? Are we witnessing a pre-poll rally and the gains will fizzle out after the elections? (Check the relation between inflows and change in Sensex returns)
Equity rally: Will it sustain or fizzle out?
This sudden rise in the equity market has taken many investors by surprise. The question is how sustainable is this rally and what is the reason for such an increase in the equity indices in the last one month. Many market experts believe that this rally is an attempt by many money managers to increase the value of their portfolio at the end of the financial year to improve their performance at the end of financial year. The analysis, however, shows otherwise.
One of the basic reasons ascribed to such increase is large inflows by foreign portfolio investors (FPIs). In the first 20 days of March 2019, they have purchased domestic stocks worth Rs 26,073 crore, which is the highest for any one month in the last two years. Last time the FPIs purchased Indian stocks in such huge quantity was in March 2017 when the BJP, the current ruling party at the Centre, won the elections in Uttar Pradesh. The FPIs had purchased shares worth Rs 31326 crore in the month of March 2017.
FPIs purchase of stocks in such huge quantities triggered a rally in the Indian market that continued for a while. We saw the frontline equity indices gaining by 21 per cent in the next 10 months. This was despite the moderation in their inflows after March 2017.
This time around, we are not even expecting moderation in the FPIs' inflows. There are couple of strong reasons for this. First, if we look at FPIs' current derivatives position in Nifty, it indicates that they have a bullish stance on the market and they will continue to remain invested. The long-short ratio is currently at the highest in the last one year. This has created a new wave of optimism among analysts, and hence, they are suggesting adding on positions, instead of booking profits.
The initial move by the FPIs in the Indian equity market may be tactical as Indian market is catching up with other emerging markets' performance as Indian equity market has been underperforming for a while. The data from MSCI, which provides global equity market indices, shows that Indian market severely underperformed other emerging markets in the last six months and generated negative return. However, in last one month, the Indian market has surpassed many markets in terms of performance and has generated positive return of nine per cent. Once this tactical move is completed, we will see that there are other reasons why FPIs will continue to invest in the Indian equity market.
US Fed decision: Help Indian equity market and inflows remain buoyant
Recently, there has been a marked shift in the stand of the US Federal Reserve regarding its interest rate policy. Till a few months back, the prospects of further rate hikes by the US Fed were high, which was leading to the weakening of the emerging market currencies and hence impacting other macroeconomic factors of the economy, such as current account.
The US Federal Reserve on March 20 indicated there might not be any more interest rate hikes this year. This development is in stark contrast to the central bank's previous stance, which had hinted at the possibility of two rate hikes in 2019. This will definitely help the Indian rupee to strengthen further, as we have witnessed it is currently trading at seven-month high against the US dollar. This dovish tone of the US Fed will help the Indian apex bank RBI to take assertive action on the interest rate front in its forthcoming bi-monthly meeting on April. This is because we cannot expect the RBI to cut its policy rates, while the US Fed is increasing its rates. What also favours a rate cut is the recent macroeconomic data. We have seen that inflation, although increasing, has remained below the RBI’s comfort level. Moreover, the growth numbers are faltering of late, which increases the chances of a rate cut to stimulate growth. Lower interest rates will help equity market to gain further. The higher returns will further attract foreign inflows. Therefore, we do not expect FPI inflows to fall, as we had witnessed earlier in 2017. It is likely to keep the momentum for a while now. Besides, there are other factors that will help the Indian equity market to perform.
Election year and MF returns
Beside the volatility in the equity market, what is also keeping investors away from the investing arena is uncertainty on the outcome of the general elections. In the general elections of 2014, the BJP (Bharatiya Janata Party) won a simple majority. It won 282 of the 543 seats in the Lok Sabha. It was the first time in an independent India that a non-Congress party won a simple majority on its own. The factors that helped it to win the election were fragmented opposition, anti-incumbency voter sentiment after 10 years of Congress party rule and moderation in economic growth.
Of all the factors discussed above, some of the factors may not be in favour of the current ruling party. However, the recent terrorist attack on Indian forces and the subsequent retaliation against the terrorists by India fanned nationalist sentiment. This may lead to nationalism trumping over economic issues and may impact voter behaviour in the upcoming elections. If this happens, it will be favourable for the BJP-led NDA government. This was also reflected in the recent poll surveys which showed that the BJP may gain due to the recent flare-up in tensions between India and Pakistan. Therefore, if the current government comes to power again, it will be a huge boost for the Indian equity market.
However, if due to some reasons, the NDA fails to come to power, will it cast a doom for the Indian equity market? Our historical analysis of the last 25 years shows that whoever wins, the ‘reforms process’ is irreversible. For example, the Goods and Services Tax (GST) and the use of Unique Identity Numbers for service delivery were initiated during the Congress party rule, which was continued by the BJP government. Moreover, the track record of the so-called 'Third Front' governments (governments that do not have participation of the two major parties at the Centre) on reforms has not always been dismal. For instance, the 1996, the 'Third Front' government presented what was seen as a “dream budget”, taking forward many economic reforms, including individual and corporate tax rates. Therefore, a coalition government may not be as bad as being portrayed by many. A weak coalition can slow the pace of reforms and even spell instability. A strong coalition, on the other hand, can prevent policy missteps.
Historically, we have seen that during the election year and one year after that, MF schemes have generated better returns. For example, in the year 2009, large-cap funds on an average generated 74.38% return, while small-cap funds gave 92.38% return. The mid-cap funds during the same period on an average generated highest return of 96.09 per cent. The above-average performance of the funds was once again repeated in year 2014. For example, small-cap funds on an average gave return of around 70 per cent. There is one more trend that gives us confidence that this year we may see equity markets giving returns better than their long term average. The data since 2001 shows that the equity markets have not generated negative returns for two years in a row.
The graph (Performance of Different MF Categories) clearly guides us on how the markets have moved over the years and how they have performed specifically in the election years. In the year prior to the election year, the markets have not performed well. However, in the election year, the markets have performed very well. The data shows that in 2008, the year before elections, the markets have not performed well with large-cap, mid-cap and small-cap giving negative returns, but in the year 2009, which was the election year, the markets performed exceptionally well. This also happened in the year 2013, which was the year prior to the election year 2014. If the current trend continues, year 2019 will be no different, and we may see better returns, a glimpse of which was visible in the last one month.
Going one step forward, we even analysed the month-wise return of the large-cap, small-cap and mid-cap stock indices to check how these indices have fared during the election year and a year before the elections.
The table above clearly shows that the year prior to the election year is normally a volatile year. However, the election years are good for mutual fund investors and have generated better returns.
Take Home : Therefore, as an investor, you should not be waiting the sidelines for the elections to get over and for a clearer picture to emerge before you invest. This may lead to sub-optimal returns. Hence, it is an opportune time to invest in equity mutual funds. You should not try to alter your asset allocation just because it is an election year and you have a view on both equity and debt markets. Invest according to your financial plan and do not shy away from taking aggressive stance on equity investment.