All Robinhood investors who opened demat accounts for the first time amid the COVID-19 pandemic affected year to make quick returns by investing in equities had early success in trading.

But now they may be in for a rough ride. The risk of losing capital is high at this juncture unless a holistic risk assessment is done.

In my view, the ten key risks the Indian equity markets face today are…

  1. Frothy valuations across market capitalisation segments

  2. India’s GDP, although has recovered and reported an expansion of +0.4% in Q3FY21, does not look very assuring enough to validate that in Q4FY21 and the ensuing quarters the Indian economy would continue to expand.

  3. India’s core sector growth and the Index of Industrial Production (IIP) data still appears frail –in fact, has contracted in the current financial year.

  4. The virus is mutating and brought in restrictions and lockdowns in certain state districts, which would weigh on economic growth.

  5. CPI inflation is still elevated due to higher food and fuel price (effectively precluding the Reserve Bank of India from reducing policy rates further to support growth).

  6. Bond yields in the United States and India have shot up.

  7. The imminent bad loan problem is a risk factor. The RBI’s Financial Stability Report (FSR) has flagged a potential surge in the Non-Performing Assets (NPAs) of the banking sector. The FSR points out NPAs could rise to 13.5% by September 2021 from 7.5% in September 2020, and under a severe stress scenario, the bad loans to 14.8%.

  8. International credit rating agencies have currently assigned the lowest investment rating just a notch above junk, and some have forecasted a negative outlook–owing to structural issues that could impede economic progress and negatively affect the government’s fiscal position.

  9. The pandemic has dented government finances; the fiscal deficit has widened and fiscal consolidation is deferred.

  10. India high debt-to-GDP ratio at 70% is also a concern.

If you are a retail or High Networth Individual (HNI) who believes that by investing in a handful of stocks you can manage the investment portfolios better than experienced fund managers, you could be wrong. Do not think making money in direct equity investing is easy.

Recently, SEBI Chief, Mr Ajay Tyagi highlighted the glaring disconnect between economic growth and the mood of equity investors while addressing a webinar organised by SEBI at the NISM Research Conference on Behaviour of Securities Markets. According to him, nearly 1 crore fresh equity accounts were opened in the first 10 months of FY21, which took the total number of accounts to 5 crore.

Further, Mr Tyagi pointed out that retail investors who were pumping in money through Systematic Investment Plans (SIPs) have begun to withdraw from mutual fund schemes. And indeed, this reflects in the recently released monthly data published by the Association of Mutual Funds in India (AMFI).

This is an indication that investors have preferred the direct equity route (via stocks) over equity mutual funds. Retail participation in the NSE Cash market has gone up 8.3% and that of institutional investors and partnership firms has reduced by an equal number.

It is unfortunate that retail investors have been shunning equity-oriented mutual funds for a while now.

Retail investors shouldn’t ignore equity-oriented mutual funds

Mutual funds are managed by professional fund managers who along with their research team track crucial market-related data. Against the amount you invest, you get a far better diversification across stock, market capitalisations, sectors, and investment styles with equity-oriented mutual funds. Plus, mutual funds offer the required cost-efficiency, liquidity, and if a prudent choice is made, it holds the potential to generate wealth for you.

When you invest in equity-oriented mutual fund schemes (and even debt-oriented schemes) , consider fund houses that follow robust investment processes and systems with efficient risk management measures. Evaluate a host of the quantitative parameters (viz. returns across time frame, returns across market cycles, risk ratios, the expense ratio, portfolio turnover, etc.) and the qualitative parameters (viz. portfolio characteristic, the credential of the fund management team, among other aspects) to make a prudent selection. Also, recognise the ideologies of the mutual fund house.

You see, if you make a thoughtful choice considering the investment objective of the respective equity-oriented scheme/s, their risk-returns traits, your personal risk appetite, your investment objective, the financial goal you wish to address and time in hand to achieve the envisioned goals, you can make the right choice wherein the risk would be well-managed and portfolio returns may optimise. Mutual Funds Sahi Hai!

Table 1: Sub-category wise average returns of equity-oriented mutual funds

Category Absolute (%) CAGR (%)
1 Year 2 Years 3 Years 5 Years 7 Years
Contra 55.1 21.2 14.5 18.2 18.1
Dividend Yield 46.1 16.8 9.6 15.2 14.5
Flexi Cap Fund 40.6 19.0 13.6 16.5 16.4
Focused Fund 42.7 19.7 13.4 17.2 17.2
Large & Mid Cap 43.0 20.0 12.7 16.9 17.7
Large Cap Fund 40.7 18.4 13.7 15.7 15.4
Mid Cap Fund 49.7 22.7 13.2 17.6 20.3
Multi Cap Fund 46.3 20.1 13.3 16.5 17.7
Small cap Fund 59.2 23.4 10.0 17.3 21.0
Value Fund 49.6 16.4 9.4 15.5 17.3
NIFTY 50 – TRI 46.9 18.6 15.5 16.7 14.2
NIFTY 500 – TRI 48.6 18.6 13.5 16.7 15.5

Data as of March 10, 2021
Source: (ACE MF, PersonalFN Research)  

The track record of various mutual fund categories suggests that certain equity-oriented mutual funds have displayed the ability to generate alpha and wealth for investors over the long term. What matters is careful scheme selection to clock above-average returns. Keep in mind, with mutual funds you tend to ward off the behavioural biases which you otherwise may be exposed to when investing stocks directly.

My experience says, here are some mistakes investors make while deploying their hard-earned savings in mutual funds and, therefore, falter on generating wealth:

  1. Skewing investments towards a particular fund house – Perhaps the investment decision is based on the assets managed by the fund, star fund manager, returns, or penchant for a big brand. But it is not true that big is beautiful, and may not be the best approach. In fact, it increases the fund house concentration risk of the mutual fund portfolio. It is important to assess the proportion of the AUM of the fund house that is actually performing, instead of deciding arbitrarily. Remember, diversification is the very basic tenet of investing and should always be followed.

  2. Over-diversify the mutual fund portfolio and buy New Fund Offers – Often investors end up buying every New Fund Offer (NFO) that hits the street or add the existing schemes to their portfolio based on recent returns. But this is not a prudent approach and often overcrowds the portfolio. Remember, “Too much of anything is good for nothing!” Over-diversification does not necessarily help generate wealth. What you require is optimal diversification –only 10 to 12 best performing and the most suitable mutual fund schemes.

  3. Copying or mirror someone else’s portfolio – Following the herd or mirroring what your next-door neighbours, friends, relatives, or colleagues do with their mutual fund investments, is not a prudent approach and may not prove rewarding. “When it comes to investing, there is no such thing as a one-size-fits-all portfolio,” says Barry Ritholtz (author, newspaper columnist, and equity analyst). When you pick mutual fund schemes for your investment portfolio, it is important that you follow a need-based approach instead of simply imitating someone else’s strategy. Do not forget investing is a personalised, individualist exercise.

  4. Trading in mutual funds and abruptly discontinuing SIPs – Mutual funds as an investment avenue, are not for trading but for investing…and preferably for the long-term. When the Indian equity markets gyrate or turn volatile, do not commit the mistake of trading in mutual funds. Also, do not move out money from equity mutual funds to stocks.

    Similarly, discontinuing your existing SIPs in worthy equity mutual funds assigned to address certain financial goals is not the solution to obviate the volatility. It could derail you from achieving your financial goals. With SIPs, the inherent rupee-cost averaging feature will help mitigate the risk involved while you endeavour to compound your hard-earned money. Note that if the Indian equity market corrects from the current high — which is possible — more units would be allotted against your SIP instalment, and when the market begins to ascend again, it would compound your wealth.

    Volatility is the very nature of the equity market. It is how we use it to our advantage, perceive the situation sensibly, and devise an efficient strategy that decides our investment success. What is important is the “time in the market”, not timing the market to generate wealth.

  5. Do not bother to review their mutual fund portfolio – Although the Indian equity markets have nearly doubled since March 2020; however, every type of equity-oriented mutual fund has not fared well. For this reason, reviewing the mutual fund portfolio is essential rather than simply moving money out from mutual funds and deploying it in stocks or any other investment avenue.

    A mutual fund portfolio review will…
    • Weed out the underperformers
    • Replace underperformers with better alternatives
    • Ensure optimal diversification
    • Make sure the portfolio is liquid
    • Consolidate the portfolio
    • Rebalance the portfolio, if necessary based on your needs
    • Potentially improve the risk-adjusted return of the portfolio
    • Make sure you are on track to accomplish the envisioned financial goals

    A buy and forget approach does not always help. Your portfolio needs to be reviewed regularly, say bi-annually or annually. And when you are deciding to cull out certain mutual funds, pay heed to the tax implications, do not ignore this.

    Just like your medical health needs attention, so does your financial health. Remember, the adage: A stitch in time saves nine.

The way forward for the Indian Equity markets…

Markets are appearing to factor in most of the positives at this juncture. Mainly the bold announcements made in the Union Budget 2021-22.

Also, the remarkable improvement in corporate earnings of most companies since March 2020 last year is a heartening factor for the Indian equities. But we need to ascertain how well the recent earning momentum sustains in the ensuing quarters. It is important that India Inc. earnings consistently improve, wherein a positive trend is visible. Currently, input costs are on the rise (due to inflation), and it poses a risk to pricing power, volumes, and margins for several companies within the respective industries.

Managements of companies are anyways hinting that the current challenges would impact revenue and net profits this financial year. The Indian equity markets may not move linearly upwards in such a scenario. For the markets to move up, ultimately earnings need to justify valuations — otherwise, markets may slip back, particularly when earnings do not meet street expectations and liquidity begins to dry up. The earnings are likely to be better, perhaps double-digits in FY23 hopefully once things begin to normalise in a post-pandemic scenario.

For RBI to play its accommodative monetary policy stance effectively to support growth, CPI inflation has to temper down. Crude oil prices have surged 75% between November and now. The impact of such a massive rise in crude oil prices on the Indian economy is expected to be inflationary given that 80% of India’s crude oil requirements are met through imports.

The Consumer Price Index (CPI) inflation in the first 11 months of FY21 has averaged at 6.3%, above RBI’s comfort range. If input cost pressures rise further, that may not go well with the equity markets (as it may hurt demand) and bond yields would also inch up further.

The hardening of 10-year treasury yields in the U.S. is already making investors jittery. From 0.93% at the beginning of 2021, the 10-year U.S. Treasury yield has hardened to 1.64%. And now some market observers have been expecting it to rise further to 2.0% over the coming few months.

[Read: Bond Yields Are Surging. What Should Be Your Debt Funds Strategy]

The rise in bond yields may tempt Foreign Portfolio Investors (FPIs)to pull out money from Indian equities and invest in their home country, as the U.S. economy is on good footing and a strong economic recovery is anticipated over the next few quarters. According to the Atlanta Federal Reserve’s estimates, the U.S. economy is likely to expand 10% in the first quarter of 2021. Inflation, too, has been moving close to the Federal Reserve’s target of 2.00% abetted by an unprecedented rise in the key commodity prices such as crude oil, copper and steel to name a few.

If FPIs pull out money from the Indian equity on the aforesaid backdrop, rampant volatility cannot be ruled out and many investors could be caught off-guard. The only satiating factor, for now, is the helicopter money policy that prevails (powered by the easy monetary policy actions by the way of near-zero or sub-zero interest rates and bond-buying programmes in the developed markets), which could allow FPIs to look at India as one of the promising emerging market investment destinations.

This is the best time to review and rebalance your portfolio

Avoid speculating and chasing the asset prices of just one asset class. Invest in accordance with the best-suited asset allocation for you, as it is the bedrock of investing. If you allocate your investible surplus smartly into various asset classes–equity, debt, and gold –it will draw in the following benefits:

  • Make timing the market irrelevant
  • Facilitate portfolio diversification
  • Minimises portfolio risk
  • Optimise portfolio returns
  • Address your liquidity needs
  • Make sure your investments are aligned with your risk profile and financial goals

If you are overweight in one asset class, say equity, considering trimming the exposure and rebalancing your portfolio at this juncture.

Considering that risk factors in play, tactically allocate around 10%-15% of your entire investment portfolio to gold via gold ETFs, gold saving funds, and/or Sovereign Gold Bonds …and hold with a long-term view. Gold will play its role as an effective portfolio diversifier, a hedge (when other asset classes fail to post alluring returns) , and command a store of value. Also, ensure you deservingly allocate towards fixed income instruments for the stability purpose of the entire investment portfolio and considering your liquidity needs.

Happy Investing!

This article first appeared on PersonalFN here

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