If anything good has come from the COVID-19 pandemic crisis, it is that it has provided us with a playbook of investment lessons. From avoiding kneejerk reactions, to holding equity for the long term and being prepared for contingencies, it has a lesson for everyone. It is how well you heed to it that will decide your success as an investor.
In the near term, the equity market is likely to be highly volatile due to the impact of the second wave of COVID-19. But as and when the visibility of economic recovery improves, the broader market can benefit and offer ample opportunities for long term investors.
To gain from the long-term growth potential of equities, begin with investing in good quality mutual fund schemes. Here is how you can select mutual funds schemes wisely amidst the pandemic:
Investment objective – Many investors often invest in mutual funds convinced by the mutual fund distributors/ agents/ relationship managers’ sales pitch. But these sale pitches can make you overlook some of the important facets you should be taking into consideration to make the right investment decision in congruence with your investment objective and risk profile.
For instance, suppose a mutual fund intermediary recommends you, the investor, to invest in a popular scheme from a large fund house and you go by their word; but in reality, if the scheme’s objective does not fit well with your personal investment objectives or needs, it would be an inappropriate fit in your investment portfolio. This could derail your wealth creation progress.
Remember, getting swayed by tall claims in the pursuit of getting wealthier is not the right approach towards investments. As an investor, it is important that you take enough responsibility and be cognizant while investing in mutual funds to make a wise investment decision.
You must refer to scheme related documents to get a better sense of the scheme objective and how it will be achieved — investment strategy, asset allocation, etc. It will also help you to understand various scheme specific risk factors that could affect its performance.
Performance indicators – Past performance can provide guidance while making an investment decision, but should not be sorely relied upon because past performance cannot be an indication of future performance. When you evaluate a mutual fund scheme, it is imperative to look at performance over longer time frames and not get lured by short-term performance.
The sharp uptrend in the equity market over the last few months has made the 1-year record of many schemes look spectacular, but only a handful will be able to sustain this performance in subsequent cycles. Therefore, do not lay high emphasis on recent returns and instead assess the fund’s performance over past market cycles compared to the benchmark and category peers.
Risk ratio – An equity-oriented scheme could be impacted by macroeconomic factors, such as changes in tax rates, political uncertainties, changes in government regulations, and industry-specific factors like competition, demand-supply dynamics, etc.
Some schemes can handle these risks in a better way when compared to the category peers and therefore are able to efficiently contain the downside risk. The point is you, the investor, should be adequately rewarded for the level of risk taken. To achieve this, schemes that fare better on risk-reward ratios, such as Standard Deviation, Sharpe Ratio, Sortino Ratio, etc., can be considered for investment.
Qualitative parameters – Analyse the fund on qualitative parameters by determining the quality of the portfolio and the efficiency of fund manager/house because they are as vital as the quantitative aspects in the selection process.
Choose a fund house that has a significant performance record and follows robust investment processes with adequate risk management systems in place.
And because a mutual fund’s performance is directly dependent on the ability of its fund manager to identify stock/sector/theme with superior potential, check the qualification and experience of the fund manager and the track record of the other schemes they manage.
Portfolio characteristics – Look at the fund’s portfolio for how well diversified it is across stocks/sectors. Remember that a concentrated portfolio can expose you, the investor, to higher risk. Ensure that the scheme optimally diversifies its portfolio within its stated investment mandate viz. multi-cap, large-cap, mid-cap, small-cap, etc. to help it sail through adverse market conditions and reduce the impact of volatility.
Understanding the portfolio characteristics can even help you get a sense of the future performance of the scheme.
Diversify – It is important to invest across various sub-categories and investment style. Invest in a well-diversified portfolio of equity funds containing Large-cap Funds, Large & Mid Cap Fund, Multi-Cap/Flexi-Cap Fund, Mid-Cap Fund, Aggressive Hybrid Fund, etc. depending on your risk profile and investment objective. By diversifying your investment across market capitalisation, you can benefit from the stability of large caps and the high growth potential of mid and small caps.
Do note that though certain categories such as Mid-cap fund and Small-cap Fund have very high return potential they are highly volatile, so invest only if you have a very high risk appetite. And even if you have a fairly substantial risk appetite, do not go overboard with your investment in the segment.
In addition, it can prove beneficial to diversify across investment styles – growth as well as value-oriented funds. Value funds act as a good portfolio diversifier when growth-oriented funds underperform. Notably, value funds category has outperformed many growth-oriented funds in the last one year.
Active v/s Passive – In the recent months, we have witnessed a flurry of new launches in passive fund space. However, the decision on whether to invest in an actively managed fund or passive fund, or a combination of both should depend on financial objective, investment horizon, and risk-taking ability.
Passive funds provide a low-cost investment offering for investors looking to earn decent returns from equities by tracking the respective benchmark index and/or underlying fund, making it ideal for new investors who have just started their investment journey and do not have the appetite for high volatility. But if your strategy is to get alpha-generating returns, you should consider investing in a well-diversified portfolio of actively managed mutual funds.
A few points to remember…
- Equity mutual funds are a long term investment vehicle and that is why you should avoid investing with a short term view. Have a long term horizon of at least 5-7 years when you invest in equity mutual funds.
- While it is important to invest with a long term view, do not follow the buy-and-forget approach. Conduct a periodic review of your portfolio to determine if it can successfully lead you on your path to achieving financial goals.
- Many people tend to trade in mutual funds like stocks and, therefore, lay a lot of emphasis on the Net Asset Value (NAV) of the scheme before investing. But in reality, you do not have to be worry worried about the NAV of the scheme being high or low because the NAV is not controlled by the demand. Notably, newly launched funds will have lower NAV than the schemes that have been in existence for quite some time.
- During extreme and volatile market conditions, investors tend to make investment decisions by trying to time the market. But the fact is, accurately forecasting the market movement is difficult even for seasoned investors. Instead, opt for the SIP route to mitigate the impact of volatility during various market cycles and benefit from the power of compounding.
Analysing the schemes on these parameters can seem like a daunting task, given that there are so many options to choose from. However, selecting the right mutual fund for your portfolio is a crucial step in achieving your financial goals. Most importantly, do your homework on each scheme before making an investment decision. Remember the words of Peter Lynch, “Know what you own, and know why you own it.”
This article first appeared on PersonalFN here