Equity mutual fund investors across categories have made bumper gains in the last one and a half years on the back of a massive rally in the equity market.

The S&P BSE Sensex crossed the milestone index level of 60,000 for the first time on September 24, 2021. It has risen more than 12,000 points since the beginning of this year, its fastest ever climb. Since the lows of March 2020, when the pandemic crisis shook the equity market, the Sensex has rallied 131%, as of September 27.

The rally is not just limited to the large-cap indices; the broader market too has scaled new highs. The S&P BSE Midcap index and S&P BSE Smallcap index have posted respective absolute returns of 159% and 215% since last year’s lows, as of September 27.

This reaffirms the resilience of the equity market, its ability to bounce back sharply after every steep fall and reward investors who choose to exercise patience.

Table: Performance of equity mutual funds over the years

Category Absolute (%) CAGR (%)
1 Year 2 Years 3 Years 5 Years 7 Years
Aggressive Hybrid Fund
Category Average 50.53 22.96 17.42 13.93 13.01
CRISIL Hybrid 35+65 – Aggressive Index 42.44 21.99 17.11 14.18 13.05
Flexi Cap Fund
Category Average 65.47 27.22 20.51 16.18 14.87
NIFTY 500 – TRI 67.67 28.43 19.46 16.58 14.42
Large Cap Fund
Category Average 61.72 24.88 18.87 15.33 14.00
NIFTY 50 – TRI 63.54 25.89 18.97 16.87 13.57
Mid Cap Fund
Category Average 75.45 36.31 23.74 17.25 17.43
Nifty Midcap 100 – TRI 84.37 37.31 20.97 15.31 16.23
Small cap Fund
Category Average 93.19 46.10 26.10 18.70 19.03
Nifty Smallcap 100 – TRI 93.16 39.31 19.81 12.80 13.34
Value Fund
Category Average 70.77 28.31 17.52 14.53 14.72
NIFTY 500 – TRI 67.67 28.43 19.46 16.58 14.42

Data as on September 27, 2021
(Source: ACE MF)  

At this point, it is pertinent to understand what mutual fund investment strategy you should adopt — whether to stay put, invest more, or book some profits.

But first, let’s find out what is driving the record rally in the equity market…

  • Accommodative monetary policy actions and stance adopted by major central banks of the world amid the COVID-19 pandemic
  • Sustained buying by domestic investors and overall positive participation by the Foreign Portfolio Investors (FPIs)
  • Stimulus packages announced by the government to support the economy amid the pandemic
  • A slew of reforms and Production Linked Incentive (PLI) schemes introduced by the government
  • Brighter prospects for economic growth after the second-wave of COVID-19 and resumption in economic activity
  • Encouraging corporate earnings in the last couple of quarters
  • Rise in exports
  • A buzzing IPO market with several issues listing at a handsome premium
  • Receding cases of new COVID-19 cases in India
  • Increase in the inoculation rate
  • Consumer confidence is improving
  • The approaching festive season

How to invest in mutual funds now?

The uptrend momentum in the equity market could continue in the near term due to increased participation from retail investors and high liquidity in the market. However, it would be unrealistic to expect similar returns year after year. Remember that markets never move in a linear fashion; there are always capricious upward and downward movements.

In case of any adverse or unexpected triggers, the market could correct 5%, 10%, or even 20% from the current levels. Historical data suggests that the market witnesses a major fall every two years or so before it bounces back again. This could impact the near-term returns of your mutual funds.

Therefore, the decision of whether you should stay put, invest more, or book some profits in mutual funds would depend mainly on your investment horizon, financial goals, and risk profile.

Here is the strategy that mutual fund investors can follow depending on their goals and investment horizon:

1) Your goal is at least 5-7 years away:

If the goal for which you are investing in mutual funds is at least 5-7 years away, there is no need to be apprehensive about the short term movement of the equity market. This could include long term financial goals such as, your retirement, children’s higher education fees, paying off home loan, etc. In this case, it makes sense to continue your mutual fund investment because the market could reach an even higher level 5-7 years down the line than where it is now. If the market corrects from here on, which is likely, you could use it as an opportunity to step up your investment in worthy mutual funds.

Maintain a diversified portfolio of mutual funds across categories like Large-Cap Funds, Flexi-Cap Funds, Mid-Cap Funds, Value Funds, and Aggressive Hybrid Funds. Decide the weightage in each of these categories based on your risk profile. And when you invest, opt for the SIP mode to average out the cost of investment and benefit from the power of compounding.

2) Your goal is 3-5 years away:

In the last 1-year period, Mid-Cap Funds and Small-Cap Funds have outpaced Large-Cap Funds with a significant margin. However, the trend may not sustain in the coming years. The valuations in the equity market have reached an expensive zone; therefore, corrections could be imminent. During bull market phases, even not-so-worthy stocks, particularly in mid-cap and small-cap segment, witness a significant uptrend. So, when the market corrects, the impact on the broader market is likely to be harsher and it could be a while before the segment fully recovers.

Accordingly, if you have a medium term investment horizon of 3-5 years, it will be imprudent to assume higher risk. Substantially reducing your allocation to riskier categories such as Mid-Cap Funds and Small-Cap Funds could prove worthwhile. Simultaneously, move to relatively safer categories such as, Large-Cap Funds, Flexi-Cap Funds, Aggressive Hybrid Funds, and Balanced Advantage Funds.

3) Your goal is less than 3 years away:

Equity mutual funds are effective long-term investment vehicles, but these can be highly volatile in the short term. As mentioned earlier, it would be unrealistic to expect mutual funds to generate similar returns as seen in the past one and a half years. Therefore, for short term goals that are less than 3 years away, it would be better to follow a conservative approach and focus on preserving wealth.

Invest predominantly in debt mutual funds such a Banking & PSU Debt Funds and Liquid Funds. Additionally, you can invest some portion in less volatile equity-oriented funds such as Large-Cap Funds and Arbitrage Funds to boost your returns.

4) You have accumulated the desired amount

It is possible that this swift rally in the equity market has enabled your mutual fund corpus to grow and achieve your financial goals sooner than expected. So if you have been investing to fulfil certain desires such as, buying your dream car, an expensive piece of jewellery, a latest gadget, a foreign trip, etc. and have accumulated the desired amount, it is perfectly fine to liquidate your mutual fund investment and realise your goals.

While doing so, ensure that it does not hinder your other financial goals. On the other hand, if you do not need the money now, it is preferable to avoid selling your mutual fund units prematurely and continue accumulating a larger corpus.

To conclude…

Investment in mutual funds should be done as per your needs and not the market movement. Remember that following a disciplined approach is the key to wealth creation. Choose suitable and worthy schemes across categories and sub-categories based on your goals, risk tolerance, and time horizon, and invest in a systematic manner via SIP. Lastly, conduct a periodic review of your mutual fund portfolio to eliminate and liquidate the funds that have been consistently underperforming and to rebalance if necessary.

This article first appeared on PersonalFN here

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