What Could Be the Potential Impact of a Lockdown on Your Mutual Fund Portfolio? Know Here…

Mar 30, 2020

Listen to What Could Be the Potential Impact of a Lockdown on Your Mutual Fund Portfolio? Know Here…

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The Coronavirus or COVID-19 cases are increasing by the day. The global count of confirmed cases is 6,34,835, while total deaths 29,957 reveals the World Health Organisation's (WHO's) latest situation report as of March 29, 2020. It is indeed "scary stuff" as expressed by legendary investor, Warren Buffett in an interview to CNBC a month ago.

In India as well, confirmed cases of Coronavirus have rapidly increased to 979, while the death tally is 25 as per WHO's latest situation report as of March 29, 2020.

As a measure to curb the spread of COVID-19, last week the centre-announced complete lockdown for 21 days -- the first of its kind in the history of India.

In addition, the government announced a Rs 1.75 trillion package, particularly for the poor under the Pradhan Mantri Garib Kalyan Yojana. Under this, the government has rolled out Direct Benefit Transfers (DBT); food security; free cooking gas; ex-gratia payment of Rs 1,000 for poor senior citizens; and an insurance cover of Rs 50 lakh for healthcare workers who are fighting the deadly disease.

The RBI, too, pulled out all the weapons to combat Coronavirus. The central bank (in the seventh bi-monthly monetary policy statement, 2019-20), in an exceptional move, cut policy rates and took measures to ensure that liquidity conditions remain comfortable. This was a coordinated effort (although a bit behind the curve) as the US Federal Reserve, Bank of England, Bank of Canada, Reserve Bank of New Zealand, among others also cut interest rates on the backdrop of the global Coronavirus pandemic (and to address slowing growth).

However, this is bound to cost the exchequer dear -- particularly at a time when India's GDP has been slowing down. The fiscal deficit target is likely to go for a toss and GDP is expected to come at least a couple of percentage points lower in Q4FY20 and Q1FY21. In other words, we will plunge back to the Hindu growth rate of around 3.0-3.5%, or even less. This appears inevitable as lockdown and travel bans are imposed not just in India but in many parts of the world as well.

The capital markets are rightly reading the repercussions on global trade (with travel bans imposed), bottlenecks in doing businesses (due to supply chain disruptions), corporate earnings, the global economy, and global growth prospects.

The World Trade Organisation expects a "substantial" impact on the global economy.

This is an unprecedented situation for Indian mutual fund investors as well. The S&P BSE Sensex has plummeted nearly 30% since the all-time high of January 20, 2020 (while the fall in the mid-caps and small-caps has been even more noticeable since their respective peaks in January 2018).

Image source: pixabay.com; photo courtesy: dawnfu
 

That being said, valuation-wise the Indian equity markets now look attractive and the margin of safety seems relatively comfortable with the trail P/E of the S&P BSE Sensex below 20x. Even the trail P/E of the mid-cap and small-cap segment is far lower than their earlier highs.

However, the uncertainty on the spread of COVID-19 in India and revenue loss on account of termination of economic activity suggests a very slow and painful recovery ahead. Highly leveraged companies are likely to find it difficult to service their loans considering many of them have already halted their operation or are functioning at an extremely sub-optimal level.

The slowdown blues and the Coronavirus pandemic are likely to impact corporate earnings. As people are quarantined, demand would remain muted and inflation risk will begin to surface, particularly in food prices.

Many companies have already lowered their revenue and earnings estimates for Q4FY20 and the next few quarters assessing the impact of a lockdown and travel bans to contain the Coronavirus pandemic. If the number of cases rises sharply -- much more than anticipated -- and if India is left with no option but to extend lockdown and travel bans, it will leave markets panting for breath and continue to remain volatile.

How mutual fund schemes will be affected?

The performance of mutual funds depends on the performance of their portfolio constituents. As corporate earnings downgrades are almost certain for the next 2-3 quarters (including the Q4FY20), it is likely to weigh on the equity markets and performance of mutual fund schemes. Volatility may have a bearing on the performance of your mutual fund schemes.

Given the vulnerability of smaller companies to deal with an unprecedented situation such as we are facing today, mid and small-cap focused funds are likely to be affected the most. Large-cap funds, on the other hand, maybe a little more stable.

How to deal with this situation?

Under prevailing market conditions, I recommend get your mutual fund portfolio reviewed. This will help you cull out underperformers, replace with deserving and suitable mutual fund schemes, reset asset allocation, restructure your investments astutely, and ensure you are on track to achieve the envisioned financial goals.

Build your mutual fund portfolio following a 'Core and Satellite' investment strategy

I am of the view that, if you have a time horizon of 7-8 years, the present volatile market conditions offer an excellent investment opportunity, especially given that valuation-wise there is a comfortable margin of safety available.

However, in the endeavour to build wealth, you need to devise a sensible strategy. The 'Core and Satellite' approach is one of the most successful and 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' holdings should form a major portion (around 65-70%) of the mutual fund portfolio and ideally should consist of a large-cap fund, multi-cap fund, and a value style fund.

The rest, say around 30-35%, can be 'Satellite' holdings consisting of a mid-cap fund, large & mid-cap fund and an aggressive hybrid fund. If the investor is willing to take the risk, a small portion could be allocated to small-cap as well in the satellite holding.

The higher allocation to 'Core', stable funds with a long-term view is expected to add a stability factor to the portfolio, while the 'Satellite' funds generate alpha by seeking high-growth opportunities as when available with the impulses.

And how to build a strategic portfolio?

To build a strategic portfolio of mutual funds, here are a few set of rules:

  • The selected mutual fund schemes should be amongst the top scorers in their respective categories. The portfolio should be built with a time horizon of at least five years.

  • It should be diversified across investment styles and fund management.

  • Each mutual fund scheme should be true to its investment style and mandate.

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

  • Each fund should have seen outperformance over at least three market cycles.

  • The portfolio should contain an adequate number of schemes in the right proportion. In short, it should carry the most optimum allocation to each scheme and investment style.

  • The number of schemes in your portfolio must be limited to seven.

  • Not more than five mutual fund schemes should be managed by the same fund manager.

  • Not more than two mutual fund schemes from the same fund house should be included in the portfolio

If you follow the aforesaid rules, the 'Core and satellite' strategy will draw in the following benefits:

  • Optimal diversification

  • Reduce the need for constant churning of your entire portfolio

  • Enable you to gain from exposure to various market capitalisations and investment styles

  • Offers sufficient cushion from the downside risk

  • Optimise risks

  • Offer the potential to outperform the markets

One could invest a lump sum or via the Systematic Investment Plan (SIP). But in the current market scenario where bouts of high volatility cannot be ruled out and patience of several investors could be tested, choosing the SIP route would prove to be sensible, particularly when addressing long-term financial goals.

[Read: Should You Stop SIPs Amid Coronavirus Outbreak and Market Fall?]

Volatility is the very nature of the Indian equity market. How you make the best use of it decides your investment success.

If you wish to invest in a readymade portfolio of top recommended equity mutual funds based on the 'Core & Satellite' approach to investing, I recommend that you subscribe to PersonalFN's Premium Report, "The Strategic Funds Portfolio For 2025 (2020 Edition)".

This premium report will help you build your optimum mutual funds portfolio for 2025 without any effort on your part. If you haven't subscribed yet, do it now!

Happy Investing!

 

Warm Regards,
Rounaq Neroy
Editor, Daily Wealth Letter




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