The sharp gyrations in the Indian equity market, as well as a correction from the lifetime high over the past few weeks, have made many equity mutual fund investors anxious about their investments. Factors such as the Russia-Ukraine conflict and the ensuing sharp rise in global crude oil prices, the US Federal Reserve’s hawkish stance, and the uncertainty about the economic growth due to the pandemic and rising inflation have robbed investors of some gains made in the last two years.

The S&P BSE 500 index is down by over 5% (as of March 10, 2022) from its lifetime high achieved in October 2021. Amid the market correction, all equity mutual funds across categories have generated negative returns in the last 1-month and 3-month periods. It is expected that the volatility in the equity market will continue throughout the year with a chance of further correction.

However, it is important to note that market corrections and high volatility are integral to equity mutual fund investment. Notably, equity market movements are cyclical in nature; bull run is followed by a steep correction and vice versa.

Graph: Indian equity market corrected from its all-time high

Data as on March 10, 2022
(Source: ACE MF) 

Timing your entry in exit in equity mutual funds can appear as an easy way to sail through the volatile nature of market. But timing the market is not everyone’s cup of tea since market movements are highly unpredictable. In fact, according to Nitin Kamath, Founder & CEO at Zerodha, less than 1% of active traders earn more money than a bank fixed deposit over a 3-year period.

Therefore, instead of timing the market, stick to equity mutual funds that can offer better protection against market risk by limiting the losses.

So, which type of equity mutual funds should you consider for investment to sail through market corrections? The answer to this will depend mainly on your risk profile, investment horizon, and financial goals.

Conservative investors looking to earn steady returns at lower risk and volatility should stick to Large-cap Mutual Funds. These funds invest in well-established businesses that can record strong earnings growth even when economic conditions look bleak. Therefore, Large-cap Funds are less susceptible to downside risk and can generate consistent returns across market phases and cycles.

Similarly, you can also consider investing in Aggressive Hybrid Funds, also known as Equity Hybrid Funds. These mutual funds invest predominantly in equities (65-80% of its assets) along with meaningful exposure in debt securities (20-35% of its assets) to reduce volatility. This approach offers you the benefit of the upside potential of equity investment at a lower risk as compared to pure equity mutual funds. A combination of these asset classes offers a high level of diversification, hence, lowering the downside risk during market corrections.

If you are willing to take a slightly higher risk, you can consider Flexi-cap Funds and/or Large & Midcap Funds. These categories follow a multi-cap approach to offer investors the benefit of diversification. Such a strategy allows funds managers with more leeway in building the portfolio, which in turn can reduce portfolio risk and mitigate volatility, thereby maximizing portfolio returns over the long term.

And if you are an investor with a high-risk profile, you can consider adding Mid-cap Funds to your portfolio. Mid-cap Funds have higher upside potential and the ability to create significant wealth for their investors compared to Large-cap Funds. Though these funds can be highly volatile during gloomy market conditions, they are less vulnerable compared to riskier categories such as Small-cap Funds and Sector/Thematic Funds.

You can invest in one or more of the above-mentioned categories after evaluating its suitability to your overall investment objective. With the right mix of equity mutual fund categories, you will benefit from optimal diversification that will help you to earn the best possible rate of return without exposing your portfolio to undue risk.

Word of caution…

Equity mutual funds have the potential to generate superior wealth for investors in the long run though they can witness high volatility and even corrections in short to medium term. Therefore, invest in equity mutual funds only if you have an investment horizon of at least 3 to 5 years.

Furthermore, avoid investing in very high-risk equity mutual fund categories such as Small-cap funds and Sector/Thematic funds unless you have a very high-risk appetite and an investment horizon of at least 7-10 years. Due to their aggressive investment mandate, these funds are prone to higher volatility in short to medium term. These funds can suffer heavy losses during market corrections compared to other equity mutual fund categories.

In addition, ensure that you invest in the best schemes within each category of equity mutual funds because not all funds are capable of limiting the downside risk. To select the best schemes within each category, it is important to assess their performance based on various quantitative and qualitative parameters. Click here to know how you can select the best equity mutual funds for your portfolio.

Lastly, when you invest in equity mutual funds, it is better to opt for the SIP (Systematic Investment Plan) mode of investing rather than committing a lump sum amount. If the market volatility continues or if the market corrects further from the present level, the inbuilt rupee-cost averaging feature of SIPs would take care of the intermittent volatility; more units will be added on during the corrective phase of the equity markets. And when the market begins to ascend again, this strategy will compound your wealth.

This article first appeared on PersonalFN here