Stocks hit upper circuits; but MFs don't.

In euphoric phases of the markets, stocks hit circuit– say 10% or 20%--and investors are left gaping in such situations. There are investors who become ecstatic and confident about their holdings. At present, some equity investors are going through this phase, especially if they have been holding some small and micro-cap stocks in equity portfolios. So far so good. The trouble however begins when they look at their mutual fund holdings. “Mutual funds move a percent a day, even on the best days when individual stocks are getting locked up in the upper circuit. I Wonder why I invest in mutual funds?” a typical question comes up. This creates a certain amount of discomfort among investors about mutual funds. A natural question which investors face is: What should one do when equity portfolios show higher appreciation than mutual funds’ portfolios? Let us address this question in detail:?

Comparing Returns?

It is a fact that an individual stock can move much faster than a mutual fund scheme investing in a basket of stocks. If a stock held in a scheme hits the upper circuit, then the net asset value of that scheme gets bumped up to the extent of the weight the stock has in the portfolio. The overall impact on the NAV will be commensurate with the movement in prices of all stocks. Something similar happens with individual investors’ equity portfolios. When a stock hits the upper circuit, not all stocks held in investors’ portfolios hit the upper circuit. The gains of the overall portfolio need to be compared to that of a mutual fund. But this is one half of the story of price performance.?

Portfolio performance depends on a host of other factors. Many individual investors bet their money on micro-cap stocks or penny stocks, where large institutional investors cannot enter due to reasons such as lack of information, liquidity, risk management principles and even investment mandates. In a broad-based rally such stocks can make quick moves, in some cases, even without supporting fundamentals. Such stocks can fly in a broad-based rally which makes many think that mutual funds are not the best vehicles to invest in equities. But mutual funds are all about sustainable wealth creation in the long-term.?

Mutual fund schemes have clearly-defined investment objectives and asset allocation. Fund managers must operate within the set rules and aim for generating returns that beat benchmark indices. In that process, most of them select stocks with a strong underlying business which should have the potential of compounding profits. This means many times mutual fund portfolios hover around stocks of well-established companies, or emerging companies with capable management. Such stocks are well-researched and there may not be surprises – both negative as well as positive—to trigger?huge volatility in stock prices.?

A fund manager would prefer a stock which moves substantially over the medium term to long term due to improved fundamentals but stays in a narrow range in the near term to a stock which is a hot favourite for a week or two and then goes nowhere for months, due to lack of fundamentals.?

Anatomy of risk?

While returns offered by individual stocks may play on the mind of investors, the best way to stay course is to focus on risks associated with it. In the good old days, there used to be cricketers that would play for the country in a test match and then disappear, such persons used to be termed as ‘one-test wonder’. Investors need to understand if they are wasting their time on chasing stocks that are a ‘few circuit wonders’.? Investors who have seen many market cycles will remember that there are many stocks which ‘disappeared’ as their underlying businesses went belly up or ill-intentioned promoters just decided to willfully defraud investors.?

The biggest risk in the stock market is the permanent loss of capital. Investors need to take informed bets while investing in equities. It is better to focus on stocks that are expected to deliver in the long-term, which mutual funds do.?

Does this mean MFs can’t be as rewarding??

Mutual funds reward investors in the long-term. They may not elevate your portfolio’s value every day. They build large pools of wealth in the long-term. Take the case of ICICI Prudential S&P BSE Sensex ETF – a scheme launched on January 10, 2003. The scheme completed twenty-one years recently and Rs 1 lakh invested in the scheme on the day of inception, has grown to Rs 26.4 lakh as on December 31, 2023. This amounts to a Compounded Annual Growth Rate (CAGR) of 16.9%. If this performance does not make you sign up for a mutual fund investment, then do let me know where else you would like to invest and make better risk adjusted returns.?

So, don’t fret the next time when you see your mutual funds’ portfolio not matching with the short-term appreciation shown by your equity portfolio.

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Disclaimer: This report is prepared in his personal capacity and neither the Author nor Money Honey Financial Services Pvt Ltd assumes any responsibility or liability for any error or omission in the content of the article. Investments in mutual funds and other risky assets are subject to market risks. Please seek advice from an investment professional before investing.

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