A steady rally in the equity market over the last three months has driven Sensex and Nifty to record highs. The S&P BSE Sensex closed at 63,523 at the end of June 22, 2023, while the Nifty 50 closed at 18,857, surpassing the previous peak seen in November 2022. The lower market caps too hit fresh highs with the S&P BSE Midcap and S&P BSE Smallcap index gaining around 12% each on a YTD basis.

Sensex touched a new record peak

Past performance is not an indicator of future returns
Data as of June 21, 2023
(Source: ACE MF) 

Below are the factors driving the positive momentum in the equity market:

  • Foreign Institutional Investors (FIIs) making a comeback in the Indian equity market and sustained confidence by domestic investors
  • Resilient GDP growth of India compared to various developed and emerging economies
  • Robust corporate earnings growth of India Inc.
  • A well-capitalised Indian banking sector
  • Government’s thrust for infrastructure and capex growth, and production-linked incentives
  • Easing inflation levels and the subsequent decision by the RBI to pause the rate hike cycle

Equity mutual funds have benefitted immensely from the upbeat market sentiments seen in recent months. With Sensex and Nifty 50 trading at record highs, it is natural that investors in equity mutual funds may be contemplating their next move.

Performance of equity mutual funds

Category Absolute CAGR
3 Months 6 Months 1 Year 3 Years 5 Years
Flexi Cap Fund 13.29 7.39 25.67 25.24 13.66
Large & Mid Cap 14.02 8.13 27.85 27.82 14.34
Large Cap Fund 11.51 5.44 23.48 23.06 12.65
Mid Cap Fund 16.63 11.08 32.08 32.49 15.93
Multi Cap Fund 14.70 8.96 30.22 30.35 15.94
Small cap Fund 17.88 13.92 36.93 42.35 18.20
Value Fund 12.68 8.06 30.04 29.35 12.98

Past performance is not an indicator of future returns
Data as of June 21, 2023
(Source: ACE MF) 

There is a possibility that this marks the beginning of a new phase of rally, which could potentially enhance the returns of equity mutual funds. However, one cannot be complacent because market rallies rarely move in a smooth one-way direction.

Do note that there are various headwinds at play that can play spoilsport in the equity market. This includes the prospects of a global slowdown that can affect the demand for Indian exports. Any potential flare up in inflation can once again raise the possibility of rate hikes. Another big worry is delay in monsoon due to the developing El Nino conditions that can lead to drought conditions and uneven rains which can lower agricultural output and elevate prices.

Driven by bull run, the valuations in the equity market do not appear to be cheap. According to Bloomberg estimates, the Nifty 50 1-year forward P/E ratio is at 19.86 times, making it the fourth most expensive market among global peers, and the most expensive emerging market. However, the valuations do not seem to be in the bubble zone either.

Regardless, it is important to approach equity mutual funds with caution. If the economic growth does not sustain as expected, it can lead to sharp corrections in the market.

In view of the above, here is the equity mutual fund investment strategy investors may follow:

1) Maintain a diversified portfolio

Often investors chase top-performing mutual fund schemes or category based on recent performance. In addition, investors are inclined to excess risk during market highs as they get swayed by the positive momentum in the equity market. This strategy might prove to be detrimental for investors financial well-being. Instead, investors may consider maintaining a well-diversified portfolio of equity mutual funds across categories such as Large Cap FundFlexi Cap FundMid Cap FundValue Fund, etc. They may also consider diversification across asset classes by adding debt mutual funds and gold to their investment portfolio to mitigate risk. Investors may be better off allocating assets in these categories and sub-categories based on their risk profile, investment objective, investment horizon, and financial circumstances.

[Read: What Should Be Your Mutual Fund Asset Allocation Strategy Amid Rising Global Uncertainty]

2) Avoid discontinuing SIP investment

Some investors prefer to stop or redeem SIPs at market peaks and wait for the market to correct to re-enter at lower levels. However, a disciplined approach is the key to successful investment. This means that if you have a long-term financial goal, which is at least 3-5 years away, it may be wise to continue SIP investments regardless of the market conditions. Stopping or redeeming SIPs before the end of goal period may potentially put a brake in the wealth creation process, and investors may end up with a lower corpus than the set financial goal. That said, for those nearing their goals, market highs may be a good time to gradually trim their equity exposure and shift to less risky avenues such as debt mutual funds and bank deposits.

[Read: What Is SIP?]

3) Avoid lumpsum investment

Lumpsum investment in equity mutual funds during market highs can be risky as they downside risk is higher. Investing through SIP may help investors mitigate the market risk by staggering the investments over a period. SIPs work on the simple principle of investing regularly across market conditions to compound wealth over the long run. Less units are purchased via SIP when the market is on an upward trend and more units are bought when there is a market downturn which averages out the cost of investment. As a result, SIP makes timing the market irrelevant, so investors do not have to worry about timing their investments.

[Read: 5 Key Benefits of Investing in Mutual Funds via SIP]

4) Review for any sharp deviation

Whenever there is a sharp movement in the market, investors may consider reviewing their mutual fund portfolio. During market highs, the equity allocation in the portfolio can possibly breach the optimal asset allocation level making the portfolio risky and more vulnerable to market downturns. Reviewing the portfolio helps investors to decide if the bull run has resulted in a sharp deviation from the targeted asset allocation. In case of deviation from the set asset allocation plan, there may be a need to rebalance the portfolio by trimming the equity allocation so that the portfolio is well-aligned with the investors’ risk profile and financial goals.

[Read: 5 Simple Steps to Perform a Mid-year Portfolio Review]

5) Avoid short-term bets

Investors often deal in mutual funds with the mind of a trader. Such investors often dump a well-performing mutual fund which has grown in value to substitute it with a scheme available at a low NAV. This can prove to be futile as it is difficult to predict the market movement. Equity investment takes time to grow and generate meaningful returns. In the near term, the equity market is prone to lot of uncertainties and volatilities which results in fluctuations in returns on equity mutual funds. However, the impact of volatility fades when one invests with a long-term view. Therefore, investors may be better off avoiding short-term risky bets. The equity market is known to reward investors who choose to exercise patience and prefer ‘time in the market’ instead of focusing on timing the market.

[Read: Do You Invest in Mutual Funds with the Mind of a Trader?]

This article first appeared on PersonalFN here

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