The recent months have been disappointing for investors who began their equity journey with regular monthly investments through systematic investment plans, particularly in large cap mutual fund schemes. Large-cap funds are usually seen as the “safe” part of an equity portfolio. But over the past year they have lost money. A monthly SIP in large-cap funds lost about 2.9% on average.
Before giving up on monthly SIPs and their benefits of discipline and long term impact, it’s worth understanding that the SIP itself does not generate returns. Your overall investment strategy and behaviour do.
SIP returns are not one broad-brush number. Look closely at your mutual fund portfolio and you’ll find that schemes across different categories such as large-cap, mid-cap and small cap have delivered very different SIP returns–not just over the past year but across different time periods (Table 1). Unlike their large cap peers, small-cap funds, which are considered relatively more risky, delivered a one-year return of 9.49% on average through monthly SIPs.
Should you ditch your large-cap fund SIP and shift to small-cap funds? No. Equity markets are divided into broad market-cap segments and each has a role in your portfolio. Returns from large-caps are relatively more stable as compared to mid-and-small caps, while the latter two are typically used to generate higher excess returns in the long run.
But you must consider the basic conditions needed for sustainable long term equity investing. Unless you build these into your equity portfolio — regardless of the market-cap segment you invest in — there will be periods when your portfolio returns not only confuse but also disappoint you.
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Prices move up and down — it’s normal
In March 2020, the equity market – represented by the Nifty 50 – crashed 40% in a few weeks. But the rebound was just as fast with April 2020 ending with gains of around 14%.
This kind of swing, or volatility, is part of the deal. You cannot expect steady, predictable returns from equity. “Let’s go back two decades. Between 2000 and 2002, investors in domestic equities made roughly 3.5% returns. This seems rather low. But anybody who held on for another four years made 14% annualised return. Markets can be irrational on the way up and on the way down, and at both times investors need to stay disciplined and do nothing,” says Kirtan Shah, founder Truvanta Wealth. He believes the gap is in expectations. He says it’s reasonable to expect 10%-12% return from a 100% equity portfolio but that return won’t come every year. “It is not uniform each year, you have to be prepared for lumpy returns,” he says.
Consider this: for someone invested for a three-year period from January 2013 to December 2015, the Nifty 50 gave an average annual return of 10.5%. Which means an investment of ₹1 lakh grew to ₹1.35 lakh. But the return each calendar year looked rather uneven — 6.76% was the 2013 calendar return, 31.39% for 2014 and -4.06% in 2015 calendar year. In other words your portfolio value can move very differently from one year to the next.
The key is to remain invested—the longer, the better.
“In markets, a sharp fall in price is volatility, which is also termed as a price correction. When prices remain in a narrow range for a long time, neither moving up nor down much, we call it a time correction. The latter is what we’re experiencing in large-caps today. But it’s worth knowing that there have been multiple such periods over the years. Every year you may see a 10% odd price correction and a time correction every two to three years,” says Rushabh Desai, founder, Rupee with Rushabh Investment Services.
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Don’t put all your eggs in one basket
Diversify by spreading your money across different types of funds. At a big picture level you need to diversify across assets — invest a little in deposits and debt funds, a little in gold and some in equity. But even within equity, you need to be spread out across different market capitalisation segments.
Table 1 shows the difference in SIP returns across time periods for funds in different market capitalisation segments. Each segment may perform well in a different period. The short term divergence in returns, particularly over one to three years, looks stark but smoothens out over time. “Every market cap segment will perform in cycles. Large-caps haven’t done well in the last four to five years and mid-and-small-caps may not do well in some other years. So diversification within equity itself is needed,” says Desai.
Short term price movement is influenced by many factors such as investor sentiment, liquidity and foreign investor interest, among others.
Over time, fundamentals and earning growth catch up, and being diversified across market segments helps manage the inherent cyclicality. Depending on your goals and your risk tolerance for short term loss, your allocation to each market capitalisation segment can differ and your investment time horizon will differ.
“We prefer to take large-cap exposure through a flexicap fund. That’s for clients who want to match a 3–5 year goal. Investing in mid-caps is best aligned for goals with an investment horizon of a minimum of five years and a minimum eight years for small caps,” says Shah.
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Give it time
Equity returns need time to compound. Companies or businesses take years to grow and become profitable. Also rarely do businesses deliver the same profit year after year. And that means stock price also takes years to grow meaningfully — you won’t get an instant jump in returns.
While prices in short term are influenced by the daily demand-supply, news and events, it does not impact the longer term potential of the underlying stock or portfolio of stocks to deliver profit or earnings growth. Over a few years, noise fades and real growth shows up.
“Price movements of a few stocks shouldn’t matter to a mutual fund investor as your fund itself will have 50-60 stocks with 10% cap in one stock. In a portfolio of four-five mutual funds the price movement of one or five stocks will not move the needle. Markets have also become more agile recently, reacting too much to news and events. In six months the market can completely change direction. Agility is important but one has to give equity at least seven to eight years for returns to compound,” says Desai.
What should you do?
Your SIP is working, but you need to give it more time and ensure it is well spread out. Market volatility, especially in times of correction, can feel unnerving as you see portfolio value declining and red marks all over. That’s when decision making moves from being rational to emotional. In such times, remind yourself of the long term goal and the basic fundamental conditions needed for equity investing. As Shah suggests, keep your long term goal in focus and do nothing in uncertain times.
If market events continue to feel emotional or out of control, it’s always better to work with a qualified advisor.