How To Approach Equity Mutual Funds Amid General Elections in India

April 2, 2024 Mutual Fund

The general elections (Lok Sabha elections) in the world’s largest democracy, India, will begin on April 19, 2024. Since the outcome of general elections can influence the country’s economic outlook, it can cause uncertainty in the equity market in the near term.

Naturally, investors may be worried about the impact of the general elections on their mutual fund portfolio.

So, let’s understand how to approach equity mutual funds amid general elections for long-term success…

How have equity markets performed during past election years?

As evidenced by historical data, markets have displayed heightened volatility in the run-up to the elections as well as the months following the elections.

Around three months before the general elections, markets usually have been watchful—like in 2004. Three months before the 2004 general election, the S&P BSE Sensex corrected -10.2%. And when the election results showed the surprising defeat of the Vajpayee-led-NDA government (despite the ‘India Shining’ campaign), Indian equities corrected further.

Performance of Indian equity markets around general elections

Data as of March 28, 2024
Past performance is not an indicator for future returns.
(Source: ACE MF, data collated by PersonalFN Research) 

In 2014, sensing the anti-incumbency owing to the corruption of the UPA regime, when the change in power was evident, and Mr Narendra Modi was projected as the Prime Ministerial candidate of the BJP-led-NDA, markets did better both, pre and post elections.

Thus, note that whenever the election results are not on expected lines, markets tend to show knee-jerk reactions in the short term. But when the new government in power continues to frame sensible policies and reforms, equity markets fare well over the long term.

[Read:  Key Investment Risks to Watch Out for in 2024]

Overall, an analysis of the past few general elections suggests that the S&P BSE Sensex consistently recorded positive returns. The Mid-cap and small-cap indices too have shined during election years, barring the 2019 Lok Sabha election, which saw mid and small-cap stocks being shunned by mutual fund managers in favour of large-cap stocks due to SEBI’s norms on mutual fund categorisation.

Performance of Indian equity markets during general election years

Data as of March 28, 2024
Past performance is not an indicator for future returns.
(Source: ACE MF, data collated by PersonalFN Research) 

Will the equity market continue to exhibit positive trends amid the 2024 Lok Sabha elections?

While equity markets have shown resilience in general election years, past performances indicate little about future growth. Moreover, election results do not have any material long-term impact on the equity market. Over a period, markets are influenced by myriad factors such as economic indicators, corporate earnings growth, and monetary policies of the central bank.

The Indian equity market is currently trading at their all-time high levels and most of the positives are already priced in. After the election results, market sentiment can go both ways – positive or negative. If the market sentiment is positive, meaning the results are as per expectations, the markets may potentially rally further.

However, if the election results are unexpected, the market sentiment may be negative, and can lead to a market correction in the short term. It is important to note that any impact of the election outcome on the market is likely to be temporary. Therefore, investors need not worry about their equity mutual fund portfolio as long as they have a sound investment strategy in place.

How to approach equity mutual fund now?

1) Stick to the asset allocation plan

The Indian equity market and the economy and markets have displayed resilience irrespective of the political backdrop. The Sensex clocked a robust CAGR of nearly 15.5% from May 2004 to May 2014 (combined UPA I and UPA II). Ever since the Modi-led-NDA government has been in power, the bellwether, S&P BSE Sensex has clocked a pleasing CAGR return of 12.7% (as of March 28, 2024).

How the Sensex has performed over the years

Data as of March 28, 2024
(Source: ACE MF, data collated by PersonalFN Research) 

Hence, instead of anticipating the election outcome, investors should focus on creating an ‘all-weather’ long-term equity portfolio that can help them sail through any sharp market outswings.

For the equity markets, corporate earnings continue to play a vital role. Thankfully, the earnings trend in the last few years has been encouraging and justifies the premium that India’s equity markets command relative to its global peers.

Thus, investors can consider diversifying their equity investment across various sub-categories such as Large Cap Funds, Mid Cap Funds, Flexi Cap Funds, Value Funds, etc., as per the asset allocation plan best suited to them.

If the financial goals for which investors are investing are nearing, they should avoid skewing their portfolios towards equities and instead shift their corpus to stable avenues such as debt mutual funds.

Sticking to the set allocation plan allows investors to avoid taking undue risk and ignore the market noise.

2) Avoid timing the market

Going by the trends of the assembly elections, the market expects a third term for the incumbent government. Some opinion polls have predicted the NDA to clinch 350+ seats out of the 543 seats, which is comfortably above the majority mark of 272. This may spell trouble for the Indian National Developmental Inclusive Alliance (INDIA) bloc. However, it is noteworthy that elections and stock market are known to throw up surprises every now and then.

This highlights that timing the market is just as difficult around general elections as it is at any other time. Thus, investors should avoid waiting on the sidelines for the election-related uncertainty and volatility to pass. They should also avoid going overboard with equity investment and tread cautiously as the markets have run up a lot and the margin of safety has narrowed.

Investing via the systematic investment plan (SIP) is a great way to reduce uncertainties and keep a long-term focus.

3) Keep emotions at bay

Investors should not allow their political opinions to overrule their investment discipline. The uncertainty and volatility in the equity market amid the general elections may make investors question their investment decision. For instance, some investors may be sceptical about starting new mutual fund investment (or continuing with their existing portfolio) if the election outcome is in contrast to general opinion.

This may induce investors to sway from long-term focus and make decisions in a haste, such as stopping or redeeming their investments. However, by doing so investors may miss out on the power of compounding of wealth.

India’s GDP real growth rate across 10 governments

Note: The number in the red rectangle is from a changed data series starting Jan 2015. While a “superior” series, there is no comparable number to equate the “New” with the “Old”. Most economists deduct 0% to 1.5% from the “New” to equate to the “Old”; therefore, under Modi, the GDP has been at 5.9% at best matching the 5.6% under the BJP-led coalition government of Vajpayee resulting in a rout for the BJP at the time of the next election in 2004.* Please note that data used for World GDP for 2021 & 2022 is a median Estimate since World Bank data is not yet available and India GDP data is the government’s third advance estimate released at the end of August 2023. Source: RBI and www.parliamentofindia.nic.in; data as of Sept 2023. 

As long as India’s GDP grows at around 6.0%, it would be decent enough to generate wealth. The graph above reveals that India’s GDP growth over the last 40 years has averaged 6-6.5%, irrespective of which political party is in power.

The nation and its equity markets have created wealth. All that the government must do is continue with its reform measures, spend money on building robust infrastructure, attract sizeable fresh investments, create jobs, and ensure that the overall policy environment remains conducive to growth.

To conclude:

Though markets have been positive in past election years, history may not necessarily repeat itself. Though the market may witness intense market volatility around the general elections, they are likely to stabilise and continue their upward growth over the long run. Thus, instead of focusing on near-term market movements, ensure that investments remain aligned towards achieving their financial goals by adopting prudent investment strategies.

Watch this video to find out whether general elections matter for the Indian equity markets:

This article first appeared on PersonalFN here