Illustration by Binay Sinha
Last year when Avantika Singh, 26, a London-based computer chip designer visited India, she was impressed by the returns that mutual funds were giving, and decided to invest in them. All the three funds that an agent sold her were small-cap, because, he said, they would give her higher returns over the long term. Today, with the one-year SIP returns
of all small-cap funds, barring one in the negative, she is wondering whether she made a wrong investment decision.
Singh is not alone. In the past couple of years, when markets were doing well, investors were over-confident about equity investing, and chanting the systematic investment plan
(SIP) mantra. The mutual fund industry, as a result, collected almost Rs 75 billion a month from this route.
Things started changing since the beginning of 2018. The correction in the mid- and small-cap categories has dented that confidence, though large-scale outflows from equity funds have not yet begun. A recent survey by UBS, however, found that investors are open to stopping further investments via the SIP route, or even redeeming their money. The report warns that retail inflows via SIPs
may stall if past returns turn negative.
Jittery after losses:
First-time investors in equities, who have not fully comprehended its volatile nature, are the ones most likely to stop their SIPs.
“Investors in India are attuned to putting money into their Employees’ Provident Fund, Public Provident Fund, fixed deposits, recurring deposits, and other such instruments where the money grows linearly. They have never seen negative returns in those products. Equities can give higher returns than them over the long term, but it comes with periods of positive and negative returns. People who do not understand this get scared when their funds show negative returns,” says Rajeev Thakkar, chief investment officer, PPFAS Mutual Fund. Such investors’ ability to withstand the pain of losses tends to be limited. “Most first-time investors can take negative returns for one or two months. But if returns continue to be negative after three or four months, they tend to stop further investments or even exit their funds,” says Vidya Bala, head of research, Fundsindia.com.
Little cause for worry:
But is there a cause for panic? Not really, if one goes by past experience. The market crash of 2008, when the Sensex fell 52.45 per cent, is a case in point. Suppose that an investor had started an SIP of Rs 1,000 in Aditya Birla Sun Life Frontline Equity (currently the largest fund by asset in the large-cap category) on January 8, 2008. The Sensex scaled a peak of 20,873 that day. The market crashed soon after. At the end of the first year, his SIP investments
would have been deeply under water, with a negative return of around 42 per cent. But if he hung on and continued his SIPs, his returns would have bounced back to a fantastic 44.6 per cent by the end of the second year. At the end of 10 years period, he would have earned an attractive 16.68 per cent (15.50 per cent by August 30 this year) annually.
The purpose of SIP investing
is to average out the cost of purchase of fund units through various market phases. “The effectiveness of an SIP increases when you go through a market downturn. That is when the cost averaging on the downside happens, that is, you buy fund units at a lower price,” says Bala. This boosts your effective return over the long term. “When an investor stops his SIP during a market decline, he effectively defeats its purpose,” adds Bala. Such a start-stop approach also prevents you from achieving your crucial financial goals.
Besides continuing with their SIPs, investors also need to avoid a few other mistakes in the current market.
Stick to the correct investment horizon: Many investors today are forgetting their earlier resolve to invest in equities for the long term. "The best antidote to the high volatility in equities is a long investment horizon. Invest for at least five to seven years in large-cap funds and seven to 10 years in mid- and small-cap funds,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India. A number-crunching exercise done by Morningstar illustrates how the risk of losses in equities declines with a longer investment horizon. "Over the past 20 years, if you had invested in the Nifty on any day and held your investment for at least seven years, you would never have made negative returns," informs Belapurkar. A long-term investment horizon becomes all the more essential for investors who entered the equity markets over the past 12 months or so when valuations, especially in the mid- and small-cap space, were high.
Do proper allocation: Investors also need to get their asset and category allocation right. “Investors who have an allocation to other asset classes like debt receive less of a shock during equity market downturns,” says Bala. She adds that within equities, investors should have higher exposure to less volatile categories like large-cap funds, and lower exposure to more volatile categories like mid- and small-cap funds. The correction this year has hit those investors particularly hard who had high exposure to the latter categories of funds.
Finally, investors need to be careful with their fund selection, as this too has the potential to pull down their returns. “Do not pick funds based on short-term historical returns. Go for one that has given sound long-term risk-adjusted returns. Also pay attention to the fund manager’s track record,” says Belapurkar.