What Should Be Your Mutual Fund Investment Strategy at a Market High

December 1, 2022 Mutual Fund

The Indian equity markets, both the Nifty 50 and the S&P BSE Sensex, as you may know, recently scaled a lifetime high. The Nifty 50 ended at 18,618.05 points and S&P BSE Sensex at 62,681.84 points on November 29, 2022 –clocking +8.3% returns on a year-to-date basis and clear outperformance compared to the global counterparts.

Table 1: How have equity markets in many parts of the world performed on a YTD basis

*Data as of November 29, 2022
(ACE MF, PersonalFN Research) 

Some of the key reasons behind Indian equities gaining the attention of all investors (domestic and foreign) are…

– Reforms are consciously being implemented by the government

– Sizeable Foreign Direct Investments (FDI) investments made in India

– A health credit offtake (at 17.2% in September 2022 v/s 7.0% a year ago),

– Buoyant core sector growth (due to higher public and private sector capex spending)

– Companies are growing organically and inorganically

– The topline and bottomline of companies are reporting encouraging growth

– And the fact that India is currently one the fastest growing major economies of the world with a demographic dividend.

Interestingly, despite policy interest rates being increased by central banks to control spiralling inflation, Indian equities have done well. And bulls in the markets opine that the markets may ascend even from the current elevated levels.

Graph 1: Nifty 50 TRI v/s Nifty 50 P/E

Data as of November 29, 2022
(Source: NSE, PersonalFN Research) 

But be cautious…

In my view, one can’t just go gung-ho and be oblivion of the external vulnerabilities and their impact on Indian equities. The U.S. Federal Reserve (Fed) has signalled that more rate hikes will be needed to tame the inflation beast. Taking cues from Fed, other central banks, including the RBI, could raise rates further at least until inflation continues to play a spoiler.

These synchronised rate hikes by central banks could push the global economy into a recession in 2023, as warned by the World Bank and the International Monetary Fund (IMF). In fact, in the U.S., early signs of recession are already visible with layoffs, drop in consumer spending, decline in housing price index, dwindling business confidence index, and overall waning economic growth (amidst high inflation). The U.S. 10-year treasury yield has inched remarkably since the start of the calendar year 2022. The European bond yield, too, has spiked as the ECB also indulged in monetary tightening. The European Commission’s autumn economic forecasts that the eurozone and most member states could head into a recession in the last quarter of 2022.

As regards India, the RBI Governor, Mr Shaktikanta Das — and many others — are of the view that we are unlikely to face a recession like in some of the advanced economies.

India, in my view, may not remain fully insulated or immune to global macroeconomic conditions and therefore, repercussions would be seen in jobs, consumer spending, business confidence, exports, and overall economic growth. Higher interest rates may deter corporates from borrowing, and those who are already leveraged may see their profit margins coming under pressure.

Don’t get caught in the earnings trap

While the corporate earnings trend has been quite encouraging, keep in mind that the oldest trick in the book is that the long-term earnings are overestimated while the near-term earnings may be toned down, particularly when we encounter headwinds.

As an investor, you need to be careful and not get carried away by upbeat long-term earnings estimates. If the geopolitical scenario turns undesirable (due to bitter Sino-relations, war, disrupted energy systems, weaponization of cyberspace, etc.) and there are supply chain disruptions, inflation will continue to stay elevated. In such cases, input costs would go up and the margins of companies may come under pressure if they are unable to pass on high costs to the end consumers. Hence, it would be incorrect to live under the impression that earnings would only improve in a linear manner.

At present, while investing in Indian equity markets — whether it is stocks or equity mutual funds — it would be wise to follow the pearls of wisdom “be fearful when others are greedy, and greedy when others are fearful,” as shared by legendary investor, Warren Buffett.

You need to set realistic post-tax return expectations and not be swayed by exuberance and excitement as champaign bottles open at Dalal Street.

Valuations are at a meaningful premium relative to global markets

Although it may seem that the P/E of the Nifty 50 index is relatively attractive compared to February last year and earnings have improved, be mindful that it is at a relative premium to most other global equity markets. At around 22x, the Nifty 50 P/E (as of November 28, 2022) looks slightly overvalued, and thus the margin of safety has reduced. If the corporate earnings growth does not sustain, valuation-wise, markets will surely look expensive.

How should you approach Indian equity markets at an all-time high?

Note that the history of the Indian equity market stands testimony to the fact that after negative events such as the downturn of 2002, the U.S. subprime mortgage crisis of 2008-09, the Dubai debt debacle of 2009-10, and later the debt crisis in Greece, the slowdown in China in 2016, and the crash at the onset of the COVID-19 pandemic in 2020; the Indian equity markets have well trounced supported by buying activity from investors. A good thing this time is that there is positive participation from retail and domestic investors — and Indian equity markets are not just dependent on foreign flows.

If your investment objective is wealth appreciation, have long-term financial goals to address, want to clock an appealing real rate of return that could counter inflation, have a high-risk appetite, have a sufficient time horizon (at least 5 years), continue to invest in the best diversified equity funds in line with your asset allocation model by devising a sensible strategy.

[Read: 7 Best Mutual Funds to Invest in 2023]

To invest in equity-oriented mutual funds at this juncture, I recommend that you follow the Core & Satellite approach, 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, Flexi-cap Fund, and a Value Fund/Contra Fund. Whereas the ‘Satellite’ holdings of the portfolio can be around 30-35%, comprising a Mid-cap Fund, a Large & Mid-cap Fund, and an Aggressive Hybrid Fund.

When you construct a Core & Satellite portfolio of equity mutual funds, make sure you do not end up over-diversifying the portfolio. Select no more than 7 to 8 best equity schemes. It would be best to ensure that no more than two equity mutual fund schemes belonging to the same fund house are included in the portfolio. Also, no more than two schemes in the portfolio should be managed by the same fund manager, all the schemes should have a strong track record of at least five years, they have outperformed over at least three market cycles, are among the top performers in their respective categories, and are abiding by the stated objectives, indicated asset allocation, and investment style.

By wisely structuring and timely reviewing the Core and Satellite portions, you would be able to add stability to the portfolio. It would boost your portfolio returns and prove to be a wealth multiplier in the long run.

Given the fact that equity markets are at an all-time high, it would be prudent to take the Systematic Investment Plan (SIP) route while following the Core & Satellite Investment strategy. Owing to the headwinds, if the Indian equity markets correct and/or turn volatile, the inherent rupee-cost averaging feature of SIPs will help mitigate the volatility, and if the market ascends you will be buying a lesser number of units yet continue to grow wealth thus enabling you to accomplish your envisioned financial goals.

Watch this video on the 5 benefits of starting a SIP.

If you are already SIP-ping in some of the best equity mutual fund schemes, do not make the mistake of stopping or discontinuing your SIPs petrified by the market volatility. It could put brakes on the power of compounding and then accomplishing important financial goals and then achieving the envisioned goal may be a challenge.

If the mutual fund schemes in your portfolio haven’t performed in this northbound journey of the Indian equity markets, then I recommend you review your mutual fund portfolio at PersonalFN. Following a scientific approach and comprehensive approach, we will tell you which schemes to replace with the best ones (taking into consideration your risk profile and asset allocation) whereby it potentially boosts your portfolio returns.

Similarly, although the equity funds may have performed but the Asset Allocation may have altered from the required level, it would be worthwhile holistically reviewing and rebalancing your investment portfolio by seeking professional advice.

Furthermore, given that the Indian equity markets could fall off the cliff if the world slips into a recession and macroeconomic conditions turn hostile, it may be sensible to hold 12 to 18 months of regular monthly expenses (including EMIs on loan) in the best Liquid Funds and/or a separate savings bank account. This shall help you be prepared for the worst while you hope for the best.

Similarly, holding around 15-20% of the total investment portfolio in gold (via Gold ETFs or Gold Funds) would prove to be a hedge and serve as a store of value in times of economic uncertainties. A World Gold Council study reveals that in periods of high inflation (of over 6%) and recession, gold has done well, proving to be an effective portfolio diversifier and a safe haven.

If you follow a sensible asset allocation — broadly 75-80% in equities, 15-20% in gold, and hold some money for an emergency in Liquid Fund/s, saving banks, and have some bank deposits; your investment portfolio will have the correct mix of stability, growth, and protection.

Keep in mind, you don’t need to time the market to make money in equity markets by investing in mutual funds. What ultimately matters is discipline, regular investing, and the ‘time in the market’ to generate wealth. So, be a thoughtful investor!

Happy Investing!

This article first appeared on PersonalFN here