Sensex @65,000: The Mutual Fund Investment Strategy to Follow Now

August 31, 2023 Mutual Fund

The party in the D-Street over the past few months has brought immense cheers to investors in equity mutual funds.

As you may know, a steady rally in the equity market between April and July 2023 has driven Sensex and Nifty to record highs. The S&P BSE Sensex touched a peak of 67,572 on July 20, 2023, though it later consolidated a bit and stabilised around the 65,000 level. Meanwhile, the Nifty 50 fell a few points shy of the 20,000 level during this period, surpassing the previous peak of around 18,800 seen in December 2022.

Notably, the key indices in India have recorded one of the highest returns among the emerging markets in the current calendar so far.

The lower market caps too hit fresh highs and outperformed the large-cap indices by a notable margin. The S&P BSE Midcap and S&P BSE Smallcap index has gained 22.1% and 25.5% respectively, on a YTD basis. The Nifty 50 and S&P BSE Sensex has gained 6.6% and 6.8% respectively, during this period.

Despite some correction in the past one month, key indices are still trading at a much higher level compared to the last year. With Sensex and Nifty 50 trading at record highs, it is natural that investors in equity mutual funds may be contemplating their next move.

In this guide, find out the investment strategy equity mutual fund investors may follow now with the equity market trading near all-time high levels.

Sensex touched a new record peak

Past performance is not an indicator of future returns
Data as of August 28, 2023
(Source: ACE MF) 

Sensex @65000: What is driving the rally?

Below are the key factors driving the positive momentum in the equity market:

• Foreign Institutional Investors (FIIs) making a comeback in the Indian equity market in a strong way and sustained confidence by domestic investors
• Resilient GDP growth of India compared to various developed and emerging economies
• Robust corporate earnings growth of India Inc.
• A well-capitalised Indian banking sector
• Government’s thrust for infrastructure and capex growth, and production-linked incentives
• Easing inflation levels and the subsequent decision by the RBI to pause the rate hike cycle

Equity mutual funds have benefitted immensely from the upbeat market sentiments seen in recent months as is evident in the table below:

Performance of equity mutual funds

Past performance is not an indicator of future returns
Data as of August 28, 2023
(Source: ACE MF) 

Is it time to sell your equity mutual funds?

Whenever the equity market reaches all-time highs, many investors tend to sell their equity mutual fund units to book profit and then wait on the sidelines for an attractive entry point.

Does this mean it is time to sell your equity mutual fund units?

Well, the answer may vary for every individual investor based on their investment objectives. While the traditional wisdom recommends buying low and selling high, the strategy is more suited for traders, and not for investors as it involves timing the market.

If an investor’s time horizon to financial goal is at least 5 years away, such as children’s higher education/wedding, retirement needs, buying a house, etc., the short-term movement in the equity market should not affect their investment decisions.

For such investors, staying invested in equity mutual funds even during market highs allows their wealth to grow and compound wealth, and thereby takes them nearer to their envisioned goal. On the other hand, if investors redeem their equity mutual fund investment only to re-enter at a lower level later, they may miss out on future gains. This can create a hurdle in their wealth-creation process.

Timing the market is futile, especially for those investing for the long term. No one can accurately predict if the market has bottomed out after a correction, or whether it will keep rising after reaching a peak. So, there is a high probability that investors’ bets may not pay off as expected. Thus, long-term investors should not be affected by market peaks and troughs.

[Read:  Do You Invest in Mutual Funds with the Mind of a Trader?]

Investors may consider selling their investments only under the following circumstances:

1. When the goal is nearing

If the goal for which investors have invested is less than 3 years away, it is time to gradually trim allocation in equity mutual funds and shift to less risky avenues such as safely-managed debt mutual funds and/or bank deposits. This will protect the corpus from any potential sharp correction at the end of the goal period.

2. When investors have achieved the desired corpus

Investors who have been investing regularly through market highs and lows would have likely accumulated a sizeable amount over a period and fulfilled their goals. Such investors may consider booking profits to protect the capital from market uncertainties and volatility.

3. Change in fundamental attributes of the mutual fund scheme

At times, the fundamental attributes of a mutual fund scheme may undergo changes, such as a change in control at the AMC level, change in investment philosophy/strategy/style of the scheme, change in scheme category, etc.

Such changes can result in the scheme following a more aggressive/conservative approach and may no longer be in congruence with the investor’s risk profile and investment objective. In such a case, investors may consider selling their mutual fund units and investing in a scheme that aligns with their investment objective.

4. Consistent underperformance of the mutual fund scheme

At the time of periodic portfolio review, it is important to compare the performance of a mutual fund scheme with its peers and the benchmark. If the mutual fund scheme that the investors have invested in has consistently underperformed most of its peers and the benchmark across various market phases, then it may be time to redeem it and replace it with a better alternative.

Do note that underperformance in the short term should not be a reason to sell a mutual fund scheme as the performance may improve in the future.

[Read:  5 Simple Steps to Perform a Mid-year Portfolio Review]

[Read:  How to Analyse Your Mutual Fund Portfolio?]

5. Financial emergency

In case of a financial emergency or an unexpected rise in major expenses, investors may consider selling their equity mutual fund units as they are highly liquid. However, selling mutual funds should be seen as a last resort, and investors may first consider utilising the corpus parked in the form of an emergency fund.

6. Change in personal circumstances

An individual’s personal circumstances may undergo changes over the years. This may result in change in priorities, which may induce investors to revisit their existing financial goals and investment approach.

For instance, investors in their twenties may be willing to take high risk but they may be satisfied with safer avenues in their forties. If the new financial goals warrant a more aggressive or conservative approach, then investors may consider selling their mutual fund units and replace them with a suitable alternative.

7. Rebalancing

Sharp movements in the equity market often lead to deviation in the investment portfolio from the set asset allocation. For instance, during a bull run, the equity allocation in the portfolio can breach the set limit, say it reaches 85% from the target allocation of 75%, and thereby make the portfolio riskier. In such a case, investors may consider trimming the allocation by selling a portion of their investment to bring it back to the original level.

How investors may approach equity mutual funds now?

Some market experts believe that India is on the cusp of a structural bull run and that the Sensex may be headed towards 100,000 mark in the coming years. This could potentially further enhance the returns of equity mutual funds. However, one cannot be complacent because market rallies rarely move in a smooth one-way direction.

Do note that there are various headwinds at play that can play spoilsport in the equity market. This includes the spillovers emanating from a weak external demand and protracted geopolitical tensions. Any potential flare-up in inflation can once again raise the possibility of rate hikes. Another big worry is the El Nino conditions that can result in shortfall in rainfall. This, in turn, can lower agricultural output and elevate prices.

Driven by the recent bull run, the valuations in the equity market do not appear to be cheap. However, the valuations do not seem to be in the bubble zone either.

Regardless, it is important to approach equity mutual funds with caution. If the economic growth and corporate earnings growth does not sustain as expected, it can lead to sharp corrections in the near term.

In view of the above, here is how investors may approach equity mutual funds now:

1) Maintain a diversified portfolio

Often investors chase top-performing mutual fund schemes or categories based on recent performance. In addition, investors are inclined to excess risk during market highs as they get swayed by the positive momentum in the equity market. This strategy might prove to be detrimental to investors’ financial well-being.

Instead, investors may consider maintaining a well-diversified portfolio of equity mutual funds across categories such as Large Cap Fund, Flexi Cap Fund, Mid Cap Fund, Value Fund, etc., depending on their risk appetite and investment objectives. Investors can also consider allocating some portion in Mid Cap Funds and Small Cap Funds if their risk appetite permits it.

[Read:  What Should Be Your Mutual Fund Asset Allocation Strategy Amid Rising Global Uncertainty]

2) Avoid discontinuing SIP investment

Some investors prefer to stop or redeem SIPs at market peaks and wait for the market to correct to re-enter at lower levels. However, a disciplined approach is the key to successful investment. This means that if the financial goal is at least 3-5 years away, it may be wise to continue SIP investments regardless of the market conditions.

Stopping or redeeming SIPs before the end of the goal period may potentially put a brake on the wealth creation process, and investors may end up with a lower corpus than the set financial goal.

[Read:  What Is SIP?]

3) Avoid lumpsum investment

Lumpsum investment in equity mutual funds during market highs can be risky as the downside risk is higher. Investing through SIP may help investors mitigate the market risk by staggering the investments over a period.

SIPs work on the simple principle of investing regularly across market conditions to compound wealth over the long run. Fewer units are purchased via SIP when the market is on an upward trend and more units are bought when there is a market downturn which averages out the cost of investment. As a result, SIP makes timing the market irrelevant, so investors do not have to worry about timing their investments.

[Read:  5 Key Benefits of Investing in Mutual Funds via SIP]

4) Review for any sharp deviation

Whenever there is a sharp movement in the market, investors may consider reviewing their mutual fund portfolio. During market highs, the equity allocation in the portfolio can possibly breach the optimal asset allocation level, making the portfolio risky and more vulnerable to market downturns.

Reviewing the portfolio helps investors to decide if the bull run has resulted in a sharp deviation from the targeted asset allocation. In case of deviation from the set asset allocation plan, there may be a need to rebalance the portfolio by trimming the equity allocation so that the portfolio is well-aligned with the investors’ risk profile and financial goals.

[Read:  5 Simple Steps to Perform a Mid-year Portfolio Review]

5) Avoid short-term bets

Investors often deal in mutual funds with the mind of a trader. Such investors often dump a well-performing mutual fund which has grown in value to substitute it with a scheme available at a low NAV. This can prove to be futile as it is difficult to predict the market movement.

Equity investment takes time to grow and generate meaningful returns. In the near term, the equity market is prone to lot of uncertainties and volatilities, which results in fluctuations in returns on equity mutual funds. However, the impact of volatility fades when one invests with a long-term view.

Therefore, investors may be better off avoiding short-term risky bets. The equity market is known to reward investors who choose to exercise patience and prefer ‘time in the market’ instead of focusing on timing the market.

[Read:  Do You Invest in Mutual Funds with the Mind of a Trader?]

Does it make sense to start SIP at market highs?

Investors looking to start the mutual fund journey or looking to make fresh investments towards their financial goals have probably wondered, ‘Is it the right time to start SIP?’

Investors often assume that if they invest during market highs, they will earn significantly lower returns because further growth may be limited.

So, does it make sense to start SIP during market highs?

The answer is Yes!

Remember, there is no ‘bad time’ to start investing via SIP if the goals are more than 5 years away. Waiting for the right time to start investing could hamper the set financial goals.

Let’s assume a monthly SIP of Rs 10,000 in HDFC Top 100 Fund, one of the oldest and popular Large Cap Mutual Fund, in January 2000. Since 2000, the large-cap index S&P BSE Sensex has scaled multiple peaks. The index closed above the 10,000 mark for the first time in 2006, above 20,000 in 2007, above 30,000 in 2017, and above 40,000 in 2019. It breached the 50,000 and subsequently the 60,000 mark in 2021, and more recently it has been hovering around the 65,000 level since July 2023.

Data from ACE MF shows a monthly investment of Rs 10,000 regularly via SIP (total investment of Rs 28.4 lakh) would have accumulated a corpus of Rs 3.64 crore as of August 28, 2023. Even after investing at all-time highs, the SIP would have grown at an impressive extended internal rate of return (XIRR) of 18.1%.

Past performance is not an indicator of future returns. The securities quoted are for illustration only and are not recommendatory.
Returns are XIRR in percentage as of August 28, 2023
Monthly SIP of Rs 10,000 over a 5-year period in Regular plan – Growth option considered
(Source: ACE MF, data collated by PersonalFN) 

The above example illustrates how investing even during market highs can offer meaningful returns. Any time is a good time to start investing as long as one invests regularly regardless of the market conditions. The equity market witnesses various events throughout the year. Most of these events do not have any long-term impact on the indices. Therefore, the equity market can always deliver healthy returns in the long run.https://www.youtube.com/embed/fWQK3vN6fmM?si=fCfV-OzS_T_pQAWY 

How to select the best mutual funds for investment with markets at all-time high?

When markets are at an all-time high, investors should avoid selecting schemes based on the recent performance. Instead, investors should evaluate the schemes on various on quantitative and qualitative parameters as mentioned below to select the best mutual fund for investing

I. Quantitative parameters

1) Past performance

While past performance is not indicative of how the fund will perform in the future, it is a useful tool to determine how consistently the scheme has performed.

Assess the SIP performance of the scheme relative to its benchmark and the category peers across various time frames such as 1-year, 3-year, 5-year, 7-year, since inception, etc.

In addition, assess how consistently the fund has performed across bear and bull market phases relative to its benchmark and the category peers. While most mutual funds perform better during market highs, the real test is to determine how well the scheme manages the downside risk during market corrections.

2) Risk-adjusted returns

With markets at an all-time high, the valuations have soared and are nearing the expensive zone. Therefore, any potential negative trigger can adversely affect the market and SIP returns. However, the impact of volatility can be mitigated if the fund manager deploys efficient risk-management techniques.

To determine a scheme’s ability to reward investors adequately for the level of risk taken, evaluate the scheme on various risk parameters such as Standard Deviation, Sharpe Ratio, Sortino Ratio, etc.

3) Portfolio quality

The performance of a mutual fund is extensively dependent on the quality of its underlying portfolio, i.e. stocks, sectors, and market cap allocation. Therefore, ensure that the scheme is well-diversified across stocks and sectors to avoid concentration risk.

Also, determine whether the fund chases momentum bets or holds each of its stock with high conviction over the long run. In case of former, the portfolio could be prone to higher volatility.

II. Qualitative parameters

Qualitative parameters are often overlooked, but they play an equally important part in selecting a winning mutual fund. Analyse the below factors to determine if the fund scores high on qualitative parameters:

1) Efficiency of the mutual fund house

Always give higher importance to fund houses that follow sound risk management techniques and have robust investment systems and processes in place. Schemes that follow prudent investment practices can be expected to form consistently well over the long run, even though they may underperform in the interim.

2) Experience of the fund manager

The performance of a mutual fund is directly dependent on the ability of its fund manager to timely identify various opportunities available in the market. This makes it crucial to check the qualification and experience of the fund manager and the track record of the other schemes they manage.

Should investors favour Mid and Small Cap Mutual Funds during market highs?

Mid Cap Small Cap Mutual Funds invest in emerging businesses and niche segments, and therefore, they can potentially deliver higher returns in the long run compared to Large Cap Funds that typically invest in matured/established businesses. This is why, Mid Cap Funds and Small Cap Funds have the potential to outpace Large Cap Funds, especially during bullish market phases. Such scenarios usually see investors flocking to invest in Mid and Small Cap Funds.

However, at present, several quality names in the mid-cap and small-cap segments are trading near their record-high levels. This implies that the margin of safety has narrowed. Even though the market could continue to rally for some more time, it is important to tread with caution.

Do note that Mid Cap Funds and Small Cap Funds are high-risk high-return investment avenues. During a market rally, even low-quality names that lack fundamentals begin to soar. Therefore, if the liquidity dries up, mid-cap and small-cap segments could feel the impact first.

When investing in smaller companies, remember that for every high-potential stock, there is a long list of stocks that can turn out to be wealth destroyers. This is especially true for small-cap stocks.

Additionally, even a mid and small-cap stock that scores high on quantitative parameters such as operating margin, ROE, P/E, and P/B may still fail to reward investors if it is not run by quality and competent management. Thus, Mid Cap Funds and Small Cap Funds can plunge lower than Large Cap Funds if the market sentiments turn negative.

Ideally, investors should avoid investing in Mid Cap Funds and Small Cap Funds with a short-term view. Only aggressive investors who have a long-term investment horizon of at least 5-7 years and the aptitude to handle severe drawdowns may consider Mid Cap Funds and Small Cap Funds.

When selecting Mid Cap Mutual Funds for the portfolio, avoid getting swayed by the recent performance and instead focus on schemes that select fundamentally sound, quality stocks for the portfolio.

To conclude…

Investment in equity mutual funds works best if it is done as per an individual’s financial needs (financial goals, risk tolerance, and investment horizon) and not the market movement. Following a disciplined approach is the key to wealth creation through equity mutual funds.

For most investors, investing in mutual funds via SIP is one of the most effective ways to achieve financial goals. However, investors must ensure that they select the best mutual funds for SIP by evaluating them on various quantitative and qualitative parameters. One should ideally avoid investing in mutual funds with a short-term view.

Additionally, investors must invest an adequate amount and continue the investments until the set goal is achieved. Lastly, a periodic review of the mutual fund portfolio is necessary to eliminate funds that have been consistently underperforming and to rebalance if necessary.

It makes sense to continue investment even during market highs and reap the benefits of the growth in the equity market. Investments in equity mutual funds are suitable for achieving long-term goals that are at least 5 years away, and thus short-term fluctuations should not be a reason to worry. For goals that are less than 5 years, investors may consider Hybrid Funds, Debt mutual funds, and bank deposits.

This article first appeared on PersonalFN here