Calm Amidst Chaos: Your Mutual Fund Roadmap

Never in history have the markets remained stable for such a long period. Volatility is the trademark of the markets that investors have to face up to. As such, what should be the strategy that investors must adopt to be able to stay invested and achieve long-term wealth generation goals? The article provides some salient tips[EasyDNNnews:PaidContentStart]
 

The equity markets are experiencing significant turbulence, primarily driven by international factors but domestic factors too have played their own role. In the first week of August, we saw a coordinated sharp decline in the global equity market, fuelled by fears of a potential U.S. recession, reversal of yen carry trade and escalating tensions in the Middle East. These concerns have led to a risk-off sentiment among investors, causing a substantial drop in key indices such as the Sensex and Nifty 50, which plummeted around 4 per cent in a matter of just three trading sessions, marking a stark reversal from the recent positive trends. 

Equity investors have more options to steer through such volatility, including quick exit and quick entry. For a mutual fund investor, it’s essential to navigate this downturn strategically and with a long-term perspective. Here’s a comprehensive guide to help you plan your investments during these volatile times. 

Understanding the Current Market Scenario 

Before diving into strategies, it’s crucial to understand the factors contributing to the current market volatility. This will help mutual investors avoid any unwarranted decisions in a hurry that they might regret going forward. 

1. Global Economic Concerns - The primary catalyst for the market decline is the growing fear of a U.S. recession. Weak economic data, particularly in the job market, has stoked concerns about an impending economic slowdown. This has led to a global sell-off, with investors moving away from riskier assets like equities. Nevertheless, the latest data from the U.S. suggests that the situation is as worse as it was perceived earlier.
2. Geopolitical Tensions - Rising tensions in the Middle East have added to the uncertainty, further unsettling the global markets. Geopolitical instability often leads to increased market volatility as investors seek safe havens. Any escalation in the situation will have a direct impact on the crude oil prices. 
3. Yen Carry Trade Reversal - The unwinding of the yen carry trade—a strategy where investors borrow in yen to invest in higher-yielding assets—has also contributed to the downward pressure on global markets. As the yen strengthens, investors are forced to close their positions, leading to a sell-off in equities. The graph below clearly shows that within a month Japanese yen has strengthened against the USD. It moved from around 158 per USD to around 142 before recovering to 146 within a month. It has gained a bit after this, though still lower than the start of the month. 

4. Valuation Concerns - Indian markets, like many others, have been trading at above long term average valuations. This correction, while sharp, is not entirely surprising given the elevated levels at which the markets were trading. It’s a reminder that markets are cyclical and corrections are a natural part of the investing landscape. Such correction is especially visible in the broader market. 

Long-Term Focus: The Key to Navigating Volatility
Most of us suffer from recency bias. In times of market downturns, it’s easy to get swayed by panic and short-term thinking and might lead to investment decisions that are not very advantageous over the long term. Successful investing requires a focus on long-term goals and a disciplined approach. Here’s why you should maintain a long-term perspective: 

Equity Mutual Funds and Inflation
The primary objective of investing in equity mutual funds is to beat inflation and build a corpus for long-term goals, such as retirement or children’s education. Market downturns, while unsettling, offer opportunities to buy more units at lower prices, which can enhance returns over the long term. To understand the return distribution of mutual funds, we did a study of rolling returns of different category of funds to find if it makes sense for a long-term investor to respond in haste to such volatilities. The following graph shows the percentage of times the average return of the different category of funds generated negative returns in different periods. We studied this return behaviour for the period between 2014 and 2024. 

It clearly shows that the probability of incurring loss is quite low if you hold funds for at least three years. Also, the percentage of time you will suffer a negative return diminishes further if you hold funds for five years. And in these five years of our study, we also do have Black Swan events like the corona virus pandemic that led to a huge decline in equity returns at that time. Therefore, if you are a long-term investor, you should not be worried about this short-term volatility. 

Systematic Investment Plans (SIPs)
Systematic investment plans (SIPs) are a powerful tool to navigate market volatility by leveraging the concept of rupee cost averaging. This approach allows you to buy more mutual fund units when the market is down and fewer units when the market is up, effectively averaging out your purchase cost over time. For example, if you are investing ₹10,000 each month through an SIP and the market drops, you might purchase 100 units at ₹100 per unit. 

The following month, if the market declines further and the unit price drops to ₹90, your ₹10,000 investment would allow you to buy approximately 111 units. Over time, this averaging effect can lead to significant wealth creation as the market recovers and the value of your units increases. If you anticipate that market volatility will persist for the next three to six months, now is an excellent time to consider increasing your SIP contributions. By doing so, you will be able to purchase even more units at lower prices, positioning yourself for greater returns when the market rebounds. 

Additionally, if you are looking to invest a lump sum, it’s advisable to stagger your investment over the coming months rather than investing it all at once. For instance, you could allocate 25 per cent of your available corpus each time the market falls below a specific level or by a fixed percentage, such as 5 per cent. This strategy helps mitigate the risk of investing a large sum at a potentially high market point and allows you to take advantage of further declines, thereby enhancing your overall returns in the long run. 

Avoiding Market Timing
Attempting to time the market—buying at low points and selling at high points—is a risky strategy that often results in lower returns. Instead, remaining invested through all market cycles allows you to benefit from the overall long-term growth of the markets. For example, an analysis of market data from 2000 to 2021 reveals that if you had missed just 10 of the best-performing days during this period, your compound annual growth rate (CAGR) would have been reduced to 7.6 per cent compared to 11.8 per cent if you had stayed invested for the entire time. Missing the top 20 days would have further slashed your annual return to just 4.9 per cent. This highlights the importance of staying invested rather than trying to time the market. The key is to give your investments time to grow, rather than attempting to predict market movements. 

Strategic Moves for Mutual Fund Investors
In the face of the current market volatility, it’s essential for mutual fund investors to adopt a strategic approach to safeguard their investments and capitalise on potential opportunities. The recent market fluctuations, driven by a mix of global economic concerns and geopolitical tensions, have underscored the importance of a disciplined and well-thoughtout investment strategy. As an investor, making informed decisions during these turbulent times can help you not only weather the storm but also position yourself for future growth. Here are some key strategies to consider: 

Continue with SIPs
Market downturns are the perfect time to stay committed to your SIPs for the reasons explained earlier. The disciplined approach of investing a fixed amount regularly helps in rupee cost averaging, enabling you to buy more units during market dips and fewer units during market highs. This strategy can lead to better returns over time as it smoothens out the volatility. We have already given details in the above paragraph. 

Rebalance Your Portfolio
Market corrections present an ideal opportunity to reassess and rebalance your portfolio. During these times, certain asset classes or sectors may have become overvalued due to substantial gains or underperformed in comparison to the broader market. Rebalancing ensures that your portfolio stays aligned with your risk tolerance and long-term investment objectives. For example, if your portfolio has been heavily invested in equities over the past 15 months, you would have likely benefited from a strong bull run. However, these equity holdings may now appear overvalued and stretched. 

In this situation, rebalancing might involve shifting some of your equity investments into other asset classes, such as debt or gold. Moving a portion of your funds into a debt mutual fund can provide more stability and lower risk during periods of market volatility. Alternatively, allocating some resources to gold, which often acts as a safe haven during market turbulence, can help protect the overall value of your portfolio. 

Additionally, if your portfolio includes investments in public sector undertakings (PSUs), which have recently outperformed and now occupy a larger portion of your portfolio, it may be time to consider rebalancing. While it might be tempting to hold on to these gains, the PSU sector could be due for a correction, either in time or price, as market conditions evolve. Reducing your exposure to PSUs could help defend your portfolio against potential downturns in this sector. 

Focus on Quality
In volatile times, it’s essential to focus on quality investments. Ensure that your mutual funds are invested in companies with strong fundamentals, stable earnings, and good management. Quality tends to endure market cycles better and recover faster when the markets stabilise. It is easier said than done. To select a good quality mutual fund scheme, there are a few important aspects that you need to be mindful of. Look for consistency of the performance of funds. Those funds with consistent returns over the last 5-10 years, outperforming the benchmark index and remaining in the top quartile in terms of performance, are ideal. Also, opt for funds with lower expense ratios as they impact your returns. For example, a difference of 1 per cent in expense ratio can significantly impact returns over the long term. 

Stay Diversified
Diversification remains a key strategy in managing risk. Ensure that your mutual fund portfolio is well-diversified across sectors, categories, and asset classes. This reduces the impact of poor performance in any one area and helps in cushioning your portfolio against volatility. 

Keep an Emergency Fund
Having an emergency fund equivalent to at least six months of living expenses is crucial. It ensures that you don’t need to liquidate your mutual fund investments during a market downturn to meet unforeseen expenses. This way, your long-term investments remain intact, allowing them to recover when the market rebounds. 

Psychological Aspect of Investing During a Downturn
Market volatility is an inevitable part of investing. While it’s tempting to seek shelter during stormy weather, history has shown that those who stay invested often reap the rewards. However, navigating through market downturns requires a strong dose of emotional intelligence in addition to a sound investment strategy. Market downturns test not just your investment strategy but also your psychological resilience. Here’s how to stay calm and focused: 

■ Avoid Panic Selling - It’s natural to feel anxious when you see your investments losing value. However, panic selling often locks in losses and prevents you from benefiting when the market eventually recovers. Instead, stay focused on your long-term goals. 

■ Tune Out the Noise - Financial news during a market downturn is often filled with doom and gloom. While staying informed is important, avoid getting caught up in the daily market movements. Remember, short-term volatility is a normal part of investing in equities. 

■ Stick to Your Plan - If you have a well-thought-out investment plan aligned with your financial goals, stick to it. Making impulsive changes based on short-term market movements can derail your long-term objectives. 

Market Downturns: A Double-Edged Sword 

Market volatility is an inherent characteristic of equity investments. While it can lead to anxiety and losses, it also presents opportunities for savvy investors. While downturns can be unsettling, they can also be a time to re-evaluate investment strategies and potentially make strategic moves. 

■ Investing in Beaten-Down Sectors: Market downturns can create opportunities for savvy investors. Some promising sectors or themes may be unfairly punished during market sell-offs, leading to undervalued stocks. This presents a chance to invest in better funds at attractive prices. However, thorough research is essential to identify such opportunities.
■ Increasing SIP Contributions: If your financial situation allows, consider increasing your SIP contributions during a market downturn. By investing more when the prices are low, you can potentially enhance your returns when the market recovers.
■ Exploring Balanced Advantage Funds (BAFs): For those who are risk-averse but want to take advantage of the current market conditions, BAFs, which invest in both equity and debt, can be a good option. BAFs’ dynamic asset allocation between debt and equities makes them especially appropriate for investors with moderate to low-risk profiles. 

Conclusion: Staying the Course Market downturns are an inevitable part of the investment journey. Although they can be unsettling, they also present opportunities for disciplined investors to build wealth over the long term. By continuing with your SIPs, rebalancing your portfolio, focusing on quality investments, and maintaining diversification, you can effectively navigate these challenging times. It’s important to remember that successful investing isn’t about timing the market, but rather spending time in the market. Stay committed to your long-term goals, resist the urge to panic, and view market downturns as opportunities to strengthen your portfolio. With a well-thought-out strategy and a calm approach, you can emerge from this period of volatility in a stronger position.

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