Are Mutual Fund Investors Making a Mistake by Investing at a Market High?

Jul 13, 2021

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Despite the strong second wave of COVID-19 over the past 2-3 months, Indian markets have not only been resilient, but have also been scaling new highs.

The Year-to-Date (YTD) returns of the leading indices have been attractive in the calendar year 2021 so far. Compared to a 13% YTD absolute returns clocked by the Nifty-50 Total Return Index (TRI), the Nifty Mid Cap 150 (TRI) and Nifty Small Cap 250 (TRI) have generated 32% and 44% absolute returns on a YTD basis.

Graph 1: Mid-cap and small-caps have outshone large-caps

Data as of July 9, 2021
Base: Rs 10,000
(Source: NSE, PersonalFN Research)
 

The receding second wave of COVID-19 (with appropriate measures taken by respective state governments), vaccine availability, the best possible efforts made to accelerate the COVID-19 vaccination drive, reforms undertaken, and stimulus measures announced to tackle the impact of this pandemic on the economy, seem to have encouraged investors to Indian equities.

Moreover, the fact is, investors have been let down by the low interest rates and tax inefficiency of some of the traditional investment avenues. They are now, therefore, exploring equities for effective wealth creation.

Graph 2: Equity oriented funds have been witnessing strong inflows of late

(Source: AMFI, PersonalFN Research)
 

Inflows into equity-oriented mutual funds have been positive for the fourth consecutive month in June 2021. The Assets Under Management (AUM) of mid-cap funds and small-cap funds witnessed the highest percentage increase on a month-on-month (m-o-m) basis in June 2021, not just as a function of the market movement but also inflows. Dividend Yield Funds and Sector/thematic funds, too, have seen traction supported by inflows.

Table 1: Growth in Folios and AUM of various sub-categories of equity-oriented schemes

Sub-categories of equity-oriented schemes No. of folios as of May 31, 2021 No. of folios as of June 30, 2021 M-o-M growth in folios Net Assets Under Management as on May 31, 2021 (Rs in crore) Net Assets Under Management as on June 30, 2021 (Rs in crore) Growth in AUM (%)
Small Cap Funds 52,97,876 55,44,829 2,46,953 80,380 85,957 7%
Mid Cap Funds 68,99,084 71,27,085 2,28,001 1,27,263 1,34,925 6%
Dividend Yield Funds 5,33,758 5,37,732 3,974 7,986 8,397 5%
Sectoral/Thematic Funds 82,43,946 85,38,521 2,94,575 1,09,318 1,14,684 5%
Large & Mid Cap Funds 51,61,295 52,73,746 1,12,451 83,718 87,753 5%
Value Fund/Contra Funds 37,40,816 38,05,543 64,727 66,005 69,008 5%
Multi Cap Funds 15,16,099 15,56,671 40,572 23,483 24,437 4%
Focused Funds 40,48,306 41,15,326 67,020 75,074 77,764 4%
Flexi Cap Funds 85,84,643 87,55,108 1,70,465 1,71,160 1,76,622 3%
ELSS 1,27,17,303 1,27,58,592 41,289 1,32,704 1,35,624 2%
Large Cap Funds 1,07,60,639 1,08,99,563 1,38,924 1,90,809 1,94,855 2%
Total 67,503,765 68,912,716 2% 10,67,899 11,10,025 4%
(Source: AMFI, PersonalFN Research)
 

This brings out four crucial findings:

  1. The unprecedented rally in smaller companies has attracted more investors. It's noteworthy that the small-cap funds have witnessed the highest positive change in the folio count in June month-on-month.

  2. At a higher market level, investors have also invested in dividend yield funds going by the inflows and jump in the AUM.

  3. Investors have favoured the flexi-cap fund route to benefit from the opportunities across market capitalisations.

  4. And not wanting to lose out on a rally in respective sectors, some investors have explored sector and thematic funds.

Along with lump sum investments, investors have continued to show trust in the Systematic Investment Plan (SIP) route, which is a positive.

A total of 21.29 lakh new SIPs were registered in June 2021 and the total number of outstanding folios stood at 4.02 crore. The SIP AUM hit an all-time high of Rs 4,83,964 crore, comprising 14% of the total industry AUM.

Amid the challenges of the COVID-19 pandemic in India, particularly the fear of a third wave, investors are right in choosing the Systematic Investment Plan (SIP) mode of investing to ride out the intermittent volatility which is very much integral to the market.

(Image source: pixabay.com; Photo courtesy Sergei Tokmakov)
 

Is it a mistake to invest in equity-oriented mutual funds at the market high?

Well, the Indian equity markets have indeed run up a lot and quickly backed by liquidity. But it is also true that corporate earnings, of late, have been encouraging.

India's corporate profits-to-GDP has touched a 10-year high of 2.63% in FY21 from a record low of 1.6% in FY20. This has come on the backdrop of favourable base effect, conscious reduction in operation cost, and scaling down on capital expenditure amidst the pandemic.

Moreover, some firms in industries such as metals, cement, chemicals, and oil refining and marketing companies have gained from higher prices in these commodities due to a global rally. Similarly, the Banking and Financial Services sector has been one of the biggest beneficiaries.

But that doesn't mean you should aggressively chase market momentum and invest in the sector and thematic funds. Neither am I implying that you should avoid investing in equities altogether at this juncture, as it would hinder the process of compounding wealth.

What you need to do is devise a sensible approach at a market high, given that chances of correction or extreme volatility cannot be ruled out. The sustainability of earnings growth will be the key for markets to scale to new highs. As we walk out of the pandemic, the operating costs may be higher, plus the low base effect is likely to fade. In other words, unless corporate earnings are maintained and do better quarter-on-quarter, year-on-year; the markets might come under severe pressure. Do not get caught in the earnings trap, wherein often the near-term estimates are being toned down while the future earnings estimates are unreasonably increased.

[Read: How to Prevent Making Mistakes While Build an Investment Portfolio]

I recommend that you follow the Core & Satellite approach to invest in equities at this juncture. It is a time-tested investment strategy followed by some of the most successful equity investors.

The term 'Core' applies to the more stable, long-term holdings of the portfolio, while the term 'Satellite' applies to the strategic portion that would help push up the overall returns of the portfolio across market conditions. The 'Core' holding should comprise around 65-70% of your equity mutual fund portfolio and consist of a Large-cap Fund, Multi-cap Fund, and Value Fund. Whereas, the 'Satellite' holdings of the portfolio can be around 30-35% comprising of a Mid-cap Fund, a Large & Mid-cap Fund, and an Aggressive Hybrid Fund.

By wisely structuring and timely reviewing the Core and Satellite portions, you would be able to add stability to the portfolio. It may also boost your portfolio returns strategically.

However, when you are building an equity portfolio based on the Core & Satellite strategy, keep in mind the following ground rules:

  1. Consider funds that have a strong track record of at least 5 years and have been amongst the top performers in their respective categories.

  2. The schemes should be diversified across investment styles and fund management.

  3. Ensure that each selected scheme abides with its stated objectives, indicated asset allocation, and investment style.

  4. You should not only invest across investment styles (such as growth and value), but also across fund houses.

  5. The mutual fund schemes should be managed by experienced and competent fund managers and belong to fund houses that have well-defined investment systems and processes in place.

  6. Not more than five schemes managed by the same fund manager should be included in the portfolio.

  7. Not more than two schemes from the same fund house shall be included in the portfolio.

  8. Each scheme that is to be included in the portfolio should have seen an outperformance over at least three market cycles.

  9. You should restrict the count of mutual fund schemes in your portfolio to seven.

I suggest opting for the Systematic Investment Plan (SIP) route while you build the portfolio of equity-oriented mutual fund schemes following the 'Core and Satellite' approach.

Moreover, do not forget to align your investments with your risk appetite, broader investment objective, financial goals, and time horizon to accomplish the envisioned financial goals.

If you judiciously follow the Core & Satellite Approach to build a portfolio of equity-oriented mutual funds, it will adduce these six benefits:

  1. Facilitate optimal diversification among equity mutual fund schemes

  2. Reduce the need to frequently churn your entire portfolio

  3. Reduce the risk to your portfolio

  4. Enable you to benefit from a variety of investment styles and strategies

  5. Create wealth cushioning the downside

  6. Help you potentially outperform the market

If you wish to invest in a readymade portfolio of top recommended equity mutual funds based on the 'Core & Satellite' approach to investing, I suggest subscribing to PersonalFN's Premium Report, "The Strategic Funds Portfolio For 2025 (2021 Edition)".


Note, the Core & Satellite investment strategy may work for you in 2021 and beyond. This premium report will help you build an optimum equity mutual funds portfolio for 2025 without any effort on your part.

At PersonalFN, we follow a comprehensive S.M.A.R.T Score Matrix to select the best mutual funds. We evaluate...

S - Systems and Processes

M - Market Cycle Performance

A - Asset Management Style

R - Risk-Reward Ratios

T - Performance Track Record

It has helped our valued mutual fund research subscribers to own some of the best equity mutual fund schemes in the investment portfolio with a commendable long-term performance track record.

If you haven't subscribed to PersonalFN's Premium Report, "The Strategic Funds Portfolio For 2025 (2021 Edition)" yet, do it now!

Happy Investing!

 

Warm Regards,
Rounaq Neroy
Editor, Daily Wealth Letter

 

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