Mutual Fund SIPs - Surely it performs

There is an eternal truth about the stock market that nobody can pick the bottom. In other words, nobody - be they hedge fund managers, mutual fund managers, private investment managers, market gurus or analysts and least of all, common investors - can ever time the market to perfection.

This is exactly where the concept of dollar-cost-averaging popularised by Benjamin Graham (considered to be the father of security analysis and value investing), as one of the top three tenets of investments for a defensive investor, comes to our rescue. Systematic investment plans (SIPs) also serve the same purpose. A SIP is an option where you invest a fixed amount in a mutual fund at regular intervals. It is a disciplined investment plan and helps reduce susceptibility to market fluctuations.

There has been a lot of discussion about the benefits of SIPs over other styles of investment. Nonetheless, we haven’t come across any comprehensive study on SIPs that can prove their superiority or for that matter even their effectiveness in creating wealth over the other options. Therefore, in one of the most comprehensive studies of its kind, we have analysed the returns of investments made through SIPs on various parameters and tried to understand how SIPs have done vis-a-vis other investments and in various time frames and market conditions.

One of the most interesting findings is that, across time periods, the returns generated by investments through a SIP have beaten the returns generated by the broader market index, the Sensex. For the 59 months ending November 2011 the median returns generated annually through a SIP work out to 7.5% compared to 5.7% produced by the Sensex over the same period. The maximum return was generated by Magnum FMCG fund that gave an annual return of 27.2%. What this means is that if you had invested Rs 1,000 every month from January 2007 (total of Rs 59,000), the total corpus at the end of November 2011 would have been a whopping Rs 1,11,852. 

Some may argue that the inclusion of sector funds might have skewed the overall performance of the equity funds. Therefore, going one step forward, we excluded the sector and tax saving funds to gauge the performance. Even after removing sector funds, the pure equity diversified funds performed better than the Sensex, though marginally. Moreover, 63% out of the total 154 funds (pure equity, excluding sector funds) or 98 funds have yielded more returns than the Sensex.

There is a very common misconception about SIPs - that they tend to perform well if you start when the market is low. We therefore tried to study what would have been the returns if one would have started investing at the peak of the market, that is, since January 2008. There too, investments through a SIP have given better returns. For the three years starting January 2008 the median return of 200 funds is 27.1% compared to 21.1% provided by the Sensex.

So one must be wondering how these funds have beaten the market by such huge margins. This is the beauty of a SIP which lies in the fact that you buy more units at a lower price (as it happened when the market fell during October 2008-March 2009) and lesser number of units at a higher price (as it happened when the market was up during January – March 2008) which in turn helps you average out your investment costs. This holds true if you have a long-term time horizon of investing, which is at least three to five years. 

There is one more remarkable finding that has emerged in this study. It is believed that the return is directly related to the risk taken to produce it. However, in our study we find that there is no direct correlation between the returns and the risks that is measured by the standard deviation of the monthly returns of the funds. On the contrary we found that there is a negative correlation between returns (we studied for 59 months’ returns) and risk. This means that the returns are far more stable than perceived.

Now let us check how the SIPs have performed vis-a-vis the lump sum investments. We assumed that an investor may invest either at the beginning of the year, middle of the year or at the end of the year. The results are not conclusive as there is a wide variation in the returns. While for the period ending February 2010 if you would have invested Rs 12000 in the month of February, every year starting from February 2007 till February 2010 the returns would have been 20.64% annually.

However, if you would have repeated the process starting in 2009, the returns would have been 34.06%. This has nothing to do with the investment style but it is more because of Lady Fortuna (the goddess of good luck) who smiled on you and because of which you were able to invest a lump sum when the market was at its lowest and hence generated such returns. A similar variation can be found if you have invested at the start and the middle of the year.

Therefore from the above discussion it is clear that ‘SIPs work in almost all market conditions’. In the last couple of years the stock markets have become unpredictable and have been volatile. It is very difficult for individual investors to decide on when to invest and time their investments. We believe that one can reap good returns in the equity markets only if you invest regularly in a disciplined manner for the long term and a SIP gives it all.

Besides, you can diversify or can be an aggressive investor using SIPs. Since investment through SIPs requires amounts as low as Rs 500 you can split your investment of say Rs 5000 per month between different mutual fund schemes depending upon your risk return appetite. To start with, we are appending a list of five funds that have given the best returns over the last five years after adjusting for volatility.