The Mutual Fund Show: How Investors Can Weather Tough Market Conditions
Investment advisors advocate patience even as the recent market volatility may have eroded the portfolios of mutual fund and equity investors.
This might, however, be the right time to start investing in mutual funds through systematic investment plans, said Harshad Patwardhan, chief investment officer–equity at Edelweiss Asset Management Ltd.
Many mid-caps are getting to interesting valuations, Patwardhan said on BloombergQuint’s weekly series The Mutual Fund Show. “Use the volatility to your advantage by doing an SIP in a good high-quality liquid mid-cap fund.”
Radhika Gupta, the chief executive officer of Edelweiss Asset Management, said patience is key when it comes to investing in mutual funds. If you look at anything on a daily or yearly basis, it’s bound to be volatile, Gupta said. “If your lens becomes five years, your gains are much more capped, and losses are even more capped.”
Watch the full conversation here:
Edited transcripts from the conversation:
People are being skeptical on mutual fund investments just when we have spent the last two years telling people about staying invested for the long term.
Radhika Gupta: Mutual funds continue to be Sahi hai, that thesis has been questioned in last 2 months. But I don’t think 1-2 months has ever defined thesis. One of the challenges is that many investors have come into mutual funds in last 1-1.5 years. They are new investors, and this may be there first correction. It is the first time they are seeing their portfolios down. 2017 is not reality. It has spoilt us. It was a year when the market were up and away.
2018 is the reality of equity markets. Mid-caps underperform large caps, things are volatile. You have 30-40 percent correction in single stocks. This is reality and it is good that you are experiencing it. If you look at anything on a daily or yearly basis, it is bound to be volatile. Things could be up 50 or down 50. But as your lens become five year, your gains are much more capped, and losses are even more capped. Your worst-case outcome for five years could be probably 1-2 percent which is what you went in for. So, you just have to broaden the time horizon and step back a little bit from the chaos.
People are getting perturbed. This is not as bad as 2008 was. We haven’t seen it go as bad as 2008 and therefore it is important to drive home the message is that what we are seeing right now is the trailer and picture may be remaining.
Harshad Patwardhan: When emotions run high, it is always good to go back to statistics just to put things in perspective. If you look at 38 years of history of Sensex returns, 28 years out of 38 years which is roughly 4 out of 5 times, Sensex has delivered positive returns. It is very important to put that in perspective. As a result of it, when we look at long term returns, we get the 16 percent number.
2017 was the market of very low volatility. It was just one way up. What you are seeing now are more normal times. We have seen this many years, over the past 1-2 decades. This is not something to be unnerved about. Volatility is in the nature of equities. You just have to hold on and not panic and it is very important at this stage of the market.
You say that volatility comes in with bang and it reduces if you stay invested over a period of time. Can you elaborate?
Radhika Gupta: The truth is none of us invest for one year or six months or 1 month. If we could have this discussion a month ago, we could have been doing it in different tone. Three weeks have changed our sentiments so much, but do we invest for three weeks, not really. When you do SIPs in equity investment, which is 5-7 years, it is just that the time horizon and when we start looking at our day to day NAVs, it becomes a lot shorter. People should not react to information in their portfolio. In 2008, you will open a screen and a stock will be down 20 percent. It could be down 20 percent for the right reasons or wrong reasons. Some regulatory rumor, but nothing is wrong in underlying business. Does that mean you should see your mutual fund portfolio and start getting worried? Then, definitely not.
The best part of mutual funds is that they are diversified instruments. Most of the portfolios are 40-50 stock portfolios. When we are making portfolios, we diversify across sectors, size caps and the whole range. So, it is never about single stock performance. The reason you do mutual fund is that you don’t have to worry about this.
Volatility becomes your friend because in volatile times you as you are able to buy more units for mutual fund from a mutual fund investors perspective and that might hold you in good stead later on.
Harshad Patwardhan: It is good for mutual fund investors because if you have done SIP, you end up doing it. It also helps for fund managers. At this point of time, there are many stocks or businesses which I like but I didn’t buy because valuations were little high for my comfort. Many of those stocks are available as some of them are down by 30-35 percent. So, volatility is not just good for the mutual fund investors but fund managers too.
Is this time different compared to 2008?
Harshad Patwardhan: For the next 6-9 months, things will remain volatile. Because if you look at negative factors which are impacting the markets, lets look at politics, it is big question mark like what will happen in May 2019 and that’s why I am saying 6-9 months. Internationally, oil prices are rising. They have crossed 85 now. When oil prices are high there are no good options from any macro perspective. In addition to that, there is a trade war between China and the U.S. which seems to be escalating and there may be collateral damage for emerging markets.
The next 6-9 months is time to be little cautious and not panic. In the medium to long term, when we say long term and say equities are delivered those kinds of returns, if we analyze, equities have generally, through the cycle or over long term, have mirrored the earnings growth. It is important to remember that we are coming out of a lack luster earnings period. FY08 to FY18, the CAGR for Nifty companies was barely 5-6 percent. From there we are getting into period where the number be significantly higher, may be in high teens. When we are entering into a period of high earnings growth, next 6-9 months, if we can navigate well, then medium to long term returns would be very good.
For next 6-9 months, tough conditions are likely. How to weather them?
Radhika Gupta: There are three things. Investors need to know why they are investing and what their goals are. But the best thing which can help them is asset allocation. The mutual fund industry has given you enough tools to help you hedge against the volatility. SIP is the natural tool which protects you against volatility. Asset allocation, making sure that you have a balance of equity and debt. I know fixed income had its challenges too, but it will help you in your portfolio. The other thing is dynamic asset allocation or balanced advantage fund which do this for you. They take advantage of market volatility by deciding when to be in equity, debt and do that shift. So, you can take advantage. Even today, you can invest in MFs with a 2-3-year horizon using some of these tools. If you are little afraid of volatility, it will help you mitigate this.
One classic mistake that people make that people look at peak the stock has touched and the subsequent fall and say if this 500 and come down to 100 then let’s buy it. I don’t think it is right approach because the guy which is buying it at 100, doesn’t know its value.
Harshad Patwardhan: One should not go by the absolute stock price but look at valuations. Many people tend to look at trailing valuations. Trailing valuations, in my view, make no sense. Although your forecast may not be accurate, one has to look at the forward earnings and decide at the basis of valuations of whether it is worth it or not.
What is the prudent area to start a SIP?
Harshad Patwardhan: This is very good time to look at mid-cap funds from a SIP perspective. They have underperformed significantly compared to large caps. Also, in last 17 years, 11 out of 17 years and 10 out of 15 years, 4 out of 5 years, so the odds of doing mid-caps well over the long term statistically are very high. Many mid-caps are getting to interesting valuations. I will not say that they are no brainers yet, but they are getting there. So, this is good time. Use the volatility to your advantage by doing a SIP in good high-quality liquid midcap fund.
If you can stomach volatility then why not a lumpsum investment and why SIP?
Harshad Patwardhan: I see these three risks which I mentioned. If you do lumpsum and some untoward incident happen, and market is down by 10 percent then what you do. So, it is prudent to do that. You might recall the second half of 2013. After taper tantrum, the emerging market and Indian market sold off. In recent memory, that was the best time for fund managers to buy stocks. Many businesses which were perfectly in good condition where available at valuations as if they are going out of business.
Do you see that scene right now?
Harshad Patwardhan: Not yet. But we might get there. So, start a SIP or STP over next 6-9 months but keep some powder dry. If some incident happens and the valuations look very attractive, that is the time to be aggressive. So, hold your nerves and put in money at that point of time. We all show long term averages in stock returns, but people who did invest in second quarter of 2009 made lots of money. People who invested in 3rd and 4th quarter of 2013 made lots of money. It is very important to highlight those aspects too.
What is happening in debt funds?
Radhika Gupta: What happened to debt funds is no doubt challenging, there has been an instance which has affected a lot of mutual funds schemes. I would tell debt investors two things. When you are investing in debt it is not a place to be cute. You invest in debt for fixed income kind of returns. For that 1-2 percent extra, don’t take chances, then go to equity. So, be very careful about the portfolio which you are investing. Most retail investors are happy doing low duration short term kind of simple funds which don’t take large credit risk and large duration risk.
In respect to the events that happened, it has happened largely in a category called credit risk which take credit risk. There is risk in fixed income just like in equities. We have to be prepared that if you invest in lower grade credit companies, defaults will happen. So, that is also reality. If you are not ready for that risk just like you are not ready for small cap risk, don’t do it, do large cap. If you are not ready for credit risk, there are lot of funds like short term, arbitrage, low duration funds. There is lot of funds which are simple and straight. Do it.