Should Falling Markets Trigger Exit From Equity Mutual Funds?

The stock markets are not in a good place with pressure increasing from unfavourable global cues. From mounting inflation worries to the ongoing confrontation between Russia and Ukraine to increased instances of the corona virus that have resulted in stringent lockdowns across China, things have been going horribly wrong. Even in India, inflationary concerns persist, as does the possibility of the Reserve Bank of India (RBI) hiking key policy rates further at the forthcoming Monetary Policy Committee (MPC) meeting in June 2022. Furthermore, Indian businesses are reporting a mixed bag of quarterly (Q4 2022) results. 

If we look at the price trend of Nifty 50, we can see that it has been falling since October 19, 2021. On the same day, it reached an all-time high of 18,604.45, which it attempted twice but failed to attain. Nifty 50 has dropped 12.85 per cent so far, indicating that this is a price correction rather than a time correction. Needless to say, the performance of equity mutual funds suffered as well, as seen in the table below.

As can be seen in the table above, all equity mutual fund categories posted negative returns between October 19, 2021 and May 20, 2022. When the performance of these categories is compared to that of Nifty 500 Total Returns Index (TRI), about 40 per cent have underperformed the Nifty 500 TRI. However, 60 per cent of the equity mutual fund categories have outperformed Nifty 500 TRI.

So, in a declining market, we often see two types of investors: those who want to leave their equity mutual funds with every drop in the market, and others who see it as an opportunity to accumulate units of equity mutual funds at lower net asset values (NAVs). However, experts believe that selling your equity investments during a down market is a bad idea. As a result, we decided to put it to the test ourselves. In order to comprehend this, we conducted a study using Nifty 500 TRI historical data.

The Study In this study, we made an investment for every 10 per cent drop in Nifty 500 TRI and then repurchased it when it recovered by 10 per cent. Furthermore, we compared this to the buy and hold strategy as well as the moving average method. In the buy and hold approach, we purchased Nifty 500 TRI and held it till the end of the term, but in the moving average strategy, we bought on positive crossover of 50-day SMA (simple moving average) and 200 day SMA and exited on negative crossover. The investigation spans from October 1999 through May 2022.

As shown in the graph above, the moving average technique outperforms the other two methods most of the time. If we look at how many times these three strategies provided negative returns, we can see that investing using the plus or minus 10 per cent guideline, the buy and hold strategy and the moving average method delivered negative returns of 31 per cent, 42 per cent and 26 per cent of the time, respectively. As a result, at least in terms of returns, selling during a down market fails miserably, whereas a tactical investment approach makes more sense.

Moving average (the tactical investing technique) surpasses the other two methods in the above table, which illustrates different risk and return characteristics. If we look at their compound annual growth rate (CAGR), there may be no difference, but when we look at risk-adjusted measures like the Sharpe and Sortino ratios, the moving average method wins again. However, even the buy and hold approach outperforms the plus or minus 10 per cent criterion. As a result, even if you consider different risk and return criteria, selling your assets during a down market in the absence of a good exit strategy does not make much sense.

“The most important quality for an investor is temperament, not intellect,” ace investor Warren Buffett once remarked. In reality, this is highly relevant in today’s market. Most investors try to exit their investments when markets turn bad and invest when markets are in euphoria owing to fear of missing out (FOMO), thereby performing the exact reverse of the ‘buy low and sell high’ approach, which leads to unfavourable outcomes.

Those who invest directly in stocks and those who invest lumpsum in equity mutual funds are the most affected by a declining market. People who invest under a systematic investment plan (SIP) benefit from rupee cost averaging. As a result, SIP investors often encounter less volatility in returns over time than lumpsum investors. This is because during a rising market, investors would buy fewer units at higher NAVs, whereas during a falling market they would buy more units at lower NAVs.

Conclusion The primary question is whether it makes sense to sell your equity investments during a down market. So, to better understand this, we conducted research in which we invested `1 lakh using the plus or minus 10 per cent guideline, the buy and hold strategy and the moving average method. Our study’s findings were rather straightforward, indicating that neither selling in a declining market (investment using the plus or minus 10 per cent rule) nor the buy and hold approach performs effectively

In reality, using a good method, such as moving averages, to enter and exit equity investments makes more sense. As a result, we feel that investing tactically is wiser. However, while this takes a significant amount of time and effort, even investing strategically with periodic re-balancing would be preferable than just exiting investments without a comprehensive strategy in place amid dropping markets.