Hop-on Hop-off To win!

Buy and hold strategy may give you good explains how DSIJ market returns. switching funds at regular interval can generate superior returns.




In the month of November 2017, SBI Small Cap Fund had stopped accepting new applications for investment. And this was not the only fund or fund house that had stopped accepting new applications for investment. There were many other funds that had also closed the doors of their funds for new investments. These funds primarily belonged from small-cap and mid-cap stocks.

One of the reasons fund houses had to take such a decision was they had reached their maximum limit of assets under management (AUMs). The rise in both inflows as well as increase in market cap of companies being held by these funds had led to such funds reaching their maximum limits.

In year 2017, the small-cap index had gone up by almost 60 per cent before going down by almost a quarter in the following year 2018. It continued its downfall till the month of February 2019 and, by that time, it had lost one-third of its value from its 2018 peak. The same was reflected in the performance of small-cap funds. Some of them performed worse than their benchmarks. Even the mid-cap funds had gone through a rough phase in the same duration. Most of investors who had started their systematic investment plan (SIP) during that period (2018-19) continue to see their investments in the red. Nonetheless, the large-cap and couple of sectoral funds that saw a mediocre performance during 2017 remained outperformers during the same period.

Funds perform in cycles

This cyclicality in the performance of the funds (both categorywise and fund-wise) lead us to a logical question of how long should you continue to hold a fund. We observed that if you continue to hold fund for a longer duration, your investment will give you a market return. Therefore, to earn superior returns, should you keep on switching funds at regular intervals? We did a study to answer this question. But before getting into that, let us first understand what the data says about a retail investor’s holding period.

Holding period of an investor

According to Association of Mutual Funds of India (AMFI), the mutual fund industry’s trade body, at the end of December 2018, almost 53 per cent of the investors remain invested in funds for more than one year and 29.73 per cent invested for more than two years. In the case of retail investors, 62.5 per cent of them remain invested in the fund for more than one year and around 41 per cent of investors remained invested for more than two years. This has been a trend for a while now.



The above table clearly shows that, other than corporates, a majority of retail investors remained invested for more than one year.

The study

To understand if it makes sense to switch funds at regular interval and whether it improves the returns, we did a study of returns generated by switching of funds at different frequency. All the equity dedicated funds in existence at the start of FY15, that is from April 2014, and are still existing, formed a part of our study. We carried out the following steps to complete our study. 




The following graph shows the returns generated and how Rs 100 would have grown adopting different strategies of switching of funds at different intervals.



Conclusion

The above analysis clearly shows how buying right and sitting tight may not generate best of returns in a mutual fund. The 'buy and hold' strategy may give you only average returns, which again is not guaranteed as we have seen that there are funds that have been languishing for years. Therefore, the better strategy is to actively manage your mutual fund investment and keep on moving your investment to best funds, even if it means paying exit load and higher short term taxes. The returns generated by following this strategy are superior than the 'buy and hold' strategy. This is despite our assumption that your investment will grow at average returns generated by funds lying in top 25% in terms of performance.

It is easier said than done to keep on switching your funds frequently to earn better returns. Identifying the future winner in the short term is very difficult. One of the ways to do this is to check the performance of the fund during the previous period. If it has remained in the top 25% in terms of performance; the chances are high that it will remain there over the next period. Nonetheless, calculating this for an investor becomes cumbersome because of availability of the data and then processing it.

Therefore, we at DSIJ have developed a methodology that has the potential to identify the future winner in the short term. We analyse the underlying of each equity dedicated fund to come out with the expected returns of the fund in the next one year. You can find the list of funds and their expected next one year returns at https://www.dsij.in/mutual-fund. Our back-testing has shown that our estimation of next one year return and actual returns generated by the fund are highly correlated, at least for three months. You can use it to generate superior returns on your investments.