Decoding The MFReturn Formula

The month of March 2021 brought cheers to many mutual fund houses as after a gap of eight months the inflows in the equity-dedicated mutual funds turned positive again. The last time such a phenomenon occurred i.e. a positive net inflow in equity schemes was in the month of June 2020 and that too of only Rs240 crore. Those who think that it is due to the March impact as many investors rush to invest in tax savings’ mutual funds would have to re-think since this was not the case. Almost all the categories saw a positive inflow, except for value or contra funds.

Many experts believe that it is too early to judge that the spike in inflows means the return of investors towards equity mutual funds. There is another factor that might have come into play. It is more due to a technical reason due to which there has been a spurt in the inflows. From February 1, 2021, SEBI has mandated the allotment of MF units at the NAV according to the date and time of realisation of fund. As the banks were closed on February 27 due to it being the fourth Saturday and since February 28 was a Sunday, MF units were allotted on March 1, 2021 against all the investment money realised after 3 pm on February 26, 2021.

As a result, investments made through cheques even during February 24-25, 2021 may have been reflected in the inflows of March 2021, further boosting the inflow figure. Investment through SIP saw a major impact and touched the highest ever SIP inflow of Rs9,182 crore. Therefore, we have to wait for a couple of months before we come to know if the investors are back to equity mutual funds. It is strange but true that in all these past eight months when investors pulled out money from their equity MFs, the equity market represented by BSE 500 has given positive returns most of the time.

We see there is a negative correlation between net inflows and market returns. The following graph shows the monthly inflows and monthly return of BSE 500 in the last one year ending March 2021. It has been seen that whenever the market has given positive returns, investors are quick enough to redeem their units. In a way they are trying to time the market. There is nothing wrong in it; however, if you imagine an investor who had redeemed his units in the month of July 2020, how much would he have left on the table?

This is one of the biggest reasons why investors tend to generate lower return than the funds in which they have invested. So even if you had invested in one of the best funds that have outperformed both its peers and benchmark, it may be possible that you tried to time the entry and exit and it went wrong.

Reasons for Lower Returns
In a recent study by a fund house it has been observed that the returns generated by the investor are actually lower than the fund’s return. The fund house conducted the study across three fund categories—equity, hybrid and debt funds—and used the data for 2004-20 for equity and hybrid funds and the data for 2009-20 for debt funds. The graph below summarises the study. It clearly shows that irrespective of mode of investment and category (exception of investment in debt funds through SIP), an investor tends to generate lower return than the fund. 

One of reasons for such an anomaly is that investors tend to be out of the market during the phase when the funds are generating better return. Equity returns are not steady and they come in lumps. For example, most of the pharmaceutical funds were underperforming for many years till the start of 2020. Nonetheless, in the year 2020 alone it generated returns in excess of 50 per cent that compensated for more than its previous years’ underperformance. So an investor who had invested in a pharmaceutical fund at the start of 2017 and waited for three years till the end of 2019 before which he exited would have lost a big opportunity. The cost of timing shows that investors lost when exiting the market at the time it soared suddenly.

The graph alongside shows how investors are becoming impatient while investing in mutual funds and they want quicker returns like direct equity. We have analysed the holding duration of the equity funds by a mutual fund investor. We see that most of the investors used to hold their equity MF investment for longer duration, which has now dropped. At the end of September 2013, retail investors used to hold 67.56 per cent of their investments for more than two years. It dropped to around 40 per cent in December 2018 before inching up to 55.4 per cent in December 2020. To get the best out of equity investment, the duration of any investment should be longer, else the investor will continue to get sub-optimal returns. 

Investor Behaviour
Most investors might already know that timing the market is something that even highly seasoned investors with sophisticated computing models cannot achieve consistently. Moreover, buy and hold might be one of the best strategies. A majority of investors are not accustomed to face market volatility. As volatility increases, an investor tends to cut his losses or take whatever profit is possible and then exit. Investor tends to overreact to market sentiment. Besides, short-term market movement or recency bias influences the decision making of the investor. Hence, if a fund for any reason has not performed recently, investors tend to exit from those funds.

Bridging the Gap
To match the returns of the fund, an investor should remain disciplined and focused so that he can get similar returns that the funds generate. Investment in equity-dedicated mutual fund should be done with a long-term horizon so that short-term volatility should not force you to take any wrong decision. The best way to achieve this is to follow a proper asset allocation strategy. This means investing in different asset classes as per your risk profile and to keep rebalancing your portfolio at equal intervals. Finally, you should invest in funds with a proper plan. This plan may be as simple as wealth creation. If you follow all these formulae, chances are high that there will be a difference between returns of your fund and your returns from investment in the fund.

To make the most of your mutual funds, you need a good plan and the willingness to stick with it amid all the drama in the markets.