With economic uncertainty looming large, it is only natural to re-evaluate your financial decisions. Mutual funds, as an asset class, are amongst the most accessible and potent tools for wealth creation. They fit every budget and every need, offer absolute ease of investment, transparency and liquidity. Most importantly, they are managed and closely monitored by a team of qualified professionals who are better equipped to steer through these challenging times.
Active and Passive Funds
Before you begin to review your portfolio, it’s important to understand the two kinds of funds, and what sets them apart. Mutual funds can be actively managed or passively managed. In actively managed funds, the portfolio manager uses multiple strategies for selecting the stocks in a portfolio.
Actively managed funds help diversify and switch to better investment options in case the selected portfolio isn’t working well, which is a huge advantage to investors. This is also a low-cost way of getting good investment teams to manage your money. Actively managed funds have teams that have been investing and developing their investment thesis in the fund's focus area.
Passive funds, on the other hand, require minimum intervention from the investor. Since passive funds aim to replicate the underlying index (like S&P 500 in the US, and say the Nifty or Sensex in India), the cost of managing these funds is low, therefore saving on the management cost.
Why your fund could be underperforming?
Volatility is inherent to equity investing. Active funds invest in businesses that have the potential to generate significant long-term value. There is an assumption that many active funds, especially with a higher weightage to large cap stocks, have been unable to match the growth of passive funds whose portfolio composition simply mirrors that of the index. But this isn’t the case.
Let’s clarify this by taking a look at the performance of active equity mutual funds over the past 15 years:
|15 Years CAGR Returns||Average||Maximum||Minimum||Median||Range Max Min|
|NIFTY 50 - TRI||12.72|
|Category: Large & Mid Cap||13.5091||17.4601||10.1536||13.56||7.31|
|Category: Large Cap Funds||11.97893||14.9581||7.4043||12.78||7.55|
|Category: Mid Cap Funds||14.50721||16.2371||10.5965||15.31||5.64|
|Category: Index - Nifty||11.12905||12.0952||10.1914||11.08||1.90|
(Source: Ace MF)
As we can see, in most categories, median funds have outperformed the Nifty TRI. However, SEBI recently limited the scope of large cap funds to the top 100 market cap stocks, which means that active fund managers will have to ensure that the large cap portfolio is streamlined, and funds are selected based on performance. On the other hand, Mid cap and small cap are emerging indices, so active funds in those categories will most likely outperform any passive indices on these categories.
Therefore, for investors seeking growth over the long term, it’s extremely important to select the right funds and periodically review them.
Mutual funds vs. direct stocks
Over the past year, a large number of investors have dabbled with stock trading in India. Pandemic-driven restrictions and job losses led to an increase in active investors, and the relentless stock market rally since March 2020 further drew them in. While a lot of investors managed to book profits, it’s important to remember that we don’t have such broad-based market recoveries every year. For structured wealth creation in the long term, mutual funds should be the preferred choice, as they are managed by investment experts.
Finding the right investment mix through asset allocation
The decision to invest in an asset class will depend on your financial goals, investment horizon and risk appetite. The right choice can significantly outperform the market during a bull phase and reward investors over the long-term.
That said, the best way to go about it would be through an asset allocation plan. Essentially, asset allocation is about dividing your investment portfolio into different asset categories such as stocks, fixed income, mutual funds, cash, gold, forex, real estate, etc. so as to balance the inherent investment risks, while focusing on growth. Stick to your fundamental asset allocation strategy and look to further diversify investments across sub-categories. Staying true to an asset-allocation strategy can lower the impact of volatility on your portfolio and deliver better risk-adjusted returns.
You can also adopt different asset allocation strategies, such as Life-stage allocation strategy, which works with the assumption that people usually have a greater appetite for risk at a younger age, Goal-based strategy, with which your financial goals decide your individual asset allocation, and Affluence-based strategy, which assumes that the inherent risk profile of an investor is aligned to the affluence stage of the investor.
Taking the help of a financial advisor
The services of a financial advisor during these times can be invaluable. Someone who can ensure you don’t make any investment decisions based solely on short-term performance. They assess the financial needs and investment objectives of the customer and suggest the right product mix, to help the customer stay on course as per their financial goals. If you need to re-think your financial plan, use their expertise and guidance.
The author, Prateek Mehta, is Co-founder at Scripbox. The views expressed are personal