Should You Stop Investing in Equity Mutual Funds Generating Returns Lower Than a Bank FD?

Jul 29, 2020

Equity mutual fund investors are facing a test in patience. Over the last few years, many equity mutual funds have generated considerably low returns. In some cases, the returns were even lower than what a traditional bank FD offers.

Over the 5-year period, 38% of the scheme generated returns lower than FDs (assuming a 5-year FD rate of 5.5%). Over the short term period of 1 year, a whopping 76% of the schemes registered returns lower than FDs (assuming a 1-year FD rate of 5.1%).

Probably made you wonder whether you would have been better off investing in bank FD.

Do these funds still have the potential to provide high returns?

Or, should you stop investing in equity funds generating returns lower than FD?

Let's find out...

First, comparing mutual funds and FDs will be akin to comparing apples and oranges. Equity funds are a wealth creation avenue suitable for investors with moderate to high-risk appetite looking to earn higher returns. FDs are suitable for conservative investors, aiming for safety of capital along with earning a reasonable rate of return.

Equity funds are a potent tool for long-term goals such as retirement, children's higher education/wedding expenses, buying a dream house, etc. On the other hand, bank FDs come in handy for short-term needs such as parking your emergency corpus, planning a vacation, paying off debt, etc.

Moreover, mutual funds are highly liquid and can be redeemed at any time; whereas in case of FDs, you need to hold it till maturity. FD investors earn a fixed pre-specified rate of return, while the returns on mutual funds depend on the market movement as well as the type of fund.

However, over the long term, mutual funds have been observed to generate returns in the range of 12%-15%, which is substantially higher than FDs.

So what is the reason for the underperformance of certain mutual fund schemes?

Indian equity markets were on a bull run between October 2019 and February 2020, but it was suddenly hit by the onset of the COVID-19 pandemic. S&P BSE Sensex crashed over 35% in March, from its peak in January, when the pandemic started wreaking havoc on the global economy. Unfortunately, this recent crash has dragged down the long-term returns of equity funds.

[Read: Has COVID-19 Derailed Your Retirement?]

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The market has since recovered significantly on the easing of lockdown restrictions, stimulus from the government and central bank, and in hopes of a vaccine. But uncertainty and high volatility continues to grip the markets and it is yet to claim its previous year's performance levels.

India is staring at a grim economic outlook because of the pandemic's impact on business operations and demand in most sectors. As a result, FPIs have turned net sellers in the Indian equity market, thus impacting the performance of equity instruments.

Is it still worthwhile to hold on to your investment?

Low returns are surely a cause for worry. Despite this, it makes sense to avoid any kneejerk reaction and hold on to your investment. By redeeming your investment during a market downturn you would turn a notional loss into an actual loss. It could also lead to a shortfall in achieving your desired corpus.

Given the current circumstances, it's difficult to rightly predict where the markets are headed. However, the markets do have the potential to bounce back sharply once the conditions improve. In fact, market downturns give you the valuable opportunity to buy more units at lower rates and benefit from the recovery.

[Read: Do You Own Equity Mutual Funds That Have Underperformed Their Benchmark? Read This!]

Ideally, one should exit yourequity mutual fund scheme only under the following circumstances:

  • Your investment has grown to the desired corpus

  • To gradually shift to safer avenues when your financial goal is approaching

  • The scheme underperforms consistently as compared to the benchmark and most peers

  • The fund objective changes and is no longer in congruence with your own objective

  • The fund risk profile changes and doesn't match your current risk appetite

  • In case of a financial emergency when you have no other option

So if you are holding worthy diversified equity schemes in your portfolio based on your personalized asset allocation, and if you have a long term investment horizon, you need to be patient about the short term underperformance.

It would potentially generate better rates over medium to long term through smart stock/sector selection strategy. If you are unsure if you have invested in the right scheme, get a portfolio review done.

To evaluate if you are holding potential winners, you need to assess the schemes on various quantitative and qualitative parameters such as performance track record compared to the benchmark index and category peers, risk-return-parameters, portfolio quality, as well as the efficiency of the fund manager and the fund house.

At PersonalFN, we select mutual funds on the basis of 5 variable tests, viz. Systems and Process, Market cycle performance, Asset management style, Risk-reward ratios, and Performance Track Record.

S M A R T
Systems and Processes Market Cycle Performance Asset Management Style Risk-Reward Ratios Performance Track Record
 

So, each fund recommended by PersonalFN has to go through our stringent process and tested on these five essential parameters.

Here are some stringent qualification parameters that our expert research team looks at before recommending any fund:

  • The fund manager possesses decent experience and is not overloaded with multiple schemes. Moreover, the fund house should have well-defined investment systems and processes in place.

  • The fund has successfully generated positive returns across market cycles, viz. bullish and bearish. It is important the fund has the ability to limit your losses during a crisis.

  • The portfolio should not be too concentrated, highly churned or low quality. It should be managed efficiently.

  • The fund must offer adequate return for the risk incurred. It should not be putting your money to unnecessary risk.

  • The track record of the fund in terms of generating return on investment over various time periods, i.e. 1 year, 3 years, 5 years, and so on.

This matrix was specially developed by the in-house research team at PersonalFN. We believe it's probably one of the best and most reliable fund selection methodologies in the industry today.

If you wish to select worthy mutual fund schemes, I recommend that you subscribe to PersonalFN's unbiased premium research service, FundSelect.

Additionally, as a bonus, you get access to PersonalFN's popular debt mutual fund service, DebtSelect.

Each fund recommended by PersonalFN goes through our stringent process involving both quantitative and qualitative parameters (as mentioned above before), providing you with Buy, Hold and Sell recommendations on equity and debt mutual fund schemes.

If you are serious about investing in a rewarding mutual fund scheme, Subscribe now!

 

Warm Regards,
Divya Grover
Research Analyst

 

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