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We tell you strategies to adopt while investing in equity funds
Renu Yadav/Money Today        Print Edition: November 2014
Strategies to adopt while investing in equity funds
Investing in mutual funds when the stock market is at a high level is risky.

The Sensex has risen 25% this year. Investors, it seems, have a spring in the step. Domestic investors are upbeat, and have pumped in Rs 32,244 crore in equity mutual funds in the first nine months. Over the same period last year, equity funds registered a net outflow of Rs 8,441 crore. Foreign institutional investors, or FIIs, too, have invested Rs 83,451 crore in equities, the most in the last four years. Last year they had pulled out Rs 36,576 in the first nine months.

Investing in mutual funds when the stock market is at a high level is risky. One fear is that it will fall. Second, in this market, like in all bull runs, there are too many distractions. For example, after years, small-cap funds are doing extremely well, making many distributors push these to small investors. Does this mean you should plunge headlong into these funds? No. There are many aspects one must look at, especially in rising markets, where exceptional gains in a short period can hide years of poor performance.

COMMON MISTAKES

Enter near peak and panic at fall: No one can say if India's stock markets have peaked. But one thing is clear. They have risen sharply since September last year. A lot of people keep waiting to see if the rally is for real and invest when it is about to end. This can be risky. For instance, the bulk of retail money entered stock markets between May and September, while the Sensex started rising from September 2013. The absolute return between 1 September 2013 and 14 October 2014 is 40%. Since May, the returns are a more tepid 18%. The same thing happened in 2007-08. In three months before the peak in January 2008, investors poured Rs 22,574 crore into equities. After January, panic set in, and equity funds faced huge redemptions (investors pulled out over Rs 32,000 crore from equity mutual funds in 2009-14).

Chasing NFOs and close-ended funds: Fund houses are playing smart this time. Instead of open-ended funds which investors can enter/exit any time, they are launching close-ended funds in which people can invest only during the new fund offer (NFO) period. The money is locked in for the tenure of the fund. This ensures steady fee income. But are close-ended funds good for investors?

"Until and unless the idea appeals to the investor, it doesn't make sense to invest in a close-ended fund. Investors should put 90-95% money in open-ended funds," says Anand Radhakrishnan, chief investment officer, Franklin Equity, Franklin Templeton Investments-India.

Agents sell NFOs and close-ended funds aggressively due to the high commissions that they earn on these sales. These should never be the core of your portfolio. "A lot of investment in close-ended funds is driven by financial advisors getting big commissions for lock-in products. One is not sure if these products serve the best interests of investors," says Nilesh Shetty, associate fund manager, equity, Quantum AMC.

Chasing top performers: At this stage, all equity funds are doing well, but some are giving exceptionally good returns. But everything that shines is not gold. This year's top performing fund may not do well in the long run or may not suit your portfolio because it takes too much risk to generate high returns.

In the mid- and small-cap category, HSBC Mid Cap Equity and Sundaram S.M.I.L.E. are second and third, respectively. However, on the basis of five-year returns, the two are among the bottom 10 in their category. Can these funds form the core of your long-term portfolio? No. It's better to own funds that do well consistently, say experts.

WHAT YOU SHOULD DO

Choose funds that have done well in bear markets too: Look at the fund's performance in a bad market too. Tanwir Alam, CEO, Fincart, says, "During a bull market, one should look at how the fund has been performing in downturns." This helps one understand the fund's riskreturn profile.

For example, Franklin India Taxshield and ICICI Pru Tax Plan have returned 21-22% a year for the past 10 years. But in 2008 and 2011, years when stock markets tanked, Franklin's fund did better. However, during recovery, ICICI Prudential Tax Plan did better. This shows that Franklin Taxshield doesn't rise or fall much. On the other hand, expect a bumpy ride from the ICICI Prudential's fund. So, a conservative investor will be more comfortable with Franklin Taxshield than ICICI Prudential Tax Plan.

Look for consistency rather than point-to-point returns: "Most investors look at point-to-point trailing returns of some past period. This is a mistake," says Manoj Nagpal, CEO, Outlook Asia Capital, a consulting and wealth management company. Trailing returns can give a false picture as they will be heavily influenced by how the fund has done of late. One should look at returns over discrete periods.

One can compare annual returns over three-five years. Look at returns over a complete market cycle, that is, in bear as well as bull phases.

Stick to large-cap diversified funds: Returns from large-cap diversified funds may look dull at present, but they should be the core of your portfolio. These funds have given the second-lowest returns (33%) among all categories after FMCG funds in the one year to October 13. Large-cap funds lag mid- & small-cap funds in market rallies but cushion the portfolio better during downturns. They are less volatile and provide stability to the portfolio.

Stay put for the long term, don't sell in panic: One should not try to time the market. The aim should be to invest systematically and stay invested for the long term. For instance, most people think that the worst thing a person can do is investing at the peak of the market. But data show that even if you start investing at the peak, doing so for a long period will give good results. For example, even if you had started a systematic investment plan, or SIP, in an open-ended equity fund in January 2008, you would not have lost money in any fund, except DSPBR World Gold. The average SIP return of an equity fund over this period is 16% a year.

'A lot of investment in close-ended funds is driven by advisors getting big commissions for lock-in products.', says Nilesh Shetty Associate Fund Manager-Equity, Quantum AMC
Restructure your portfolio: A market rally is a good time to clean up the portfolio. You may have invested in funds which are not doing well. Get rid of them.

For example, many people invested in infrastructure funds in the bull run of 2003-07. These funds did very poorly after 2008 but have been top performers over the last few months. If one is not too upbeat on the infrastructure theme for the long term, it is an ideal time to get rid of these funds.

Avoid sector funds: In any particular period, a few themes are likely to do better than others. For example, in the 2007 market rally, banking and infrastructure funds had a good run. When markets tanked, these were among the worst-hit funds. So, avoid investing in sector/thematic funds until and unless you are convinced about their prospects. Even then, limit your exposure to 10-15%.

'It does not make sense to invest in a close-ended fund. Investors should put 90-95% money in open-ended funds', says Anand Radhakrishnan CIO-Franklin Equity, Franklin Templeton Investments-India

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