Why mutual funds can be an efficient way to contain downside of a portfolio

In a liquidity driven rally, such as the one we have seen since 2021, many first-time investors rarely think about the downside. But when there is a correction, investors pay attention to the downside. Especially in the recent corrective phase, a few micro and small-cap stocks have lost around 30-40% from the top. If an investor has a large allocation to one such stock or a group of such stocks, then she must have incurred large losses. Compared to this, mutual funds have not fallen as much. In the past one month, the performance of large, mid and small cap?schemes has been not as bad as stocks. ?

Though one month is a too short period to judge a mutual fund scheme’s performance, in longer bearish phases, historically, mutual funds have offered better downside protection.?

Investors in mutual funds schemes stand a better chance to withstand a bear onslaught, compared to owning stock portfolios constructed by amateurs. Most diversified equity schemes benefit from two key traits of a mutual fund portfolio – diversification and continuous monitoring.?

In the context of these facts, let us understand why investment in mutual funds is an efficient way to contain the downside of your portfolio:

Diversification?

Many investors underestimate the power of diversification. Investing across asset classes, sectors and stocks can meaningfully reduce the risk for an investor. When a fund manager picks up securities with low correlation with each other, the downside is contained because not all securities go up or down together. This is especially true about investing across asset classes.

However, investing across sectors and stocks also helps. Though a broad-based move in the stock market impacts prices of most of the stocks, the impact may not be uniform. A few stocks move faster – both upwards and downwards, compared to others. If an investor is on the right side of the trend, then she makes money. However, this may not always be possible.?

Also, there is also a possibility of sector rotation. All these factors put together, build a strong case in favour of diversifying across stocks of companies in various sectors. This ensures that even in a broad-based correction, a fund manager can take exposure to stocks of companies in defensive sectors to contain the downside. A few fund managers look to own stocks of fundamentally strong companies that are quoting at attractive valuations. This quality conscious approach can also help in a bear phase. In a bearish phase, stocks of fundamentally weak companies are hammered.?

Continuous monitoring?

Building a diversified portfolio is no easy task. One requires an understanding of multiple asset classes and varied businesses. The tougher part is to keep monitoring such portfolios on a real time basis. Continuous news flow can impact stock prices. The real challenge here is to distinguish between the short-term and long-term impact. There is no need to make changes just because prices keep swinging. Identifying new opportunities and assessing progress of existing investments can help optimise returns from a portfolio. This is possible in a professional investment management set-up offered by mutual fund houses.

Professional managers can identify new investment opportunities, book profits on existing investments and cut down on evolving risks by modifying exposure to certain investments and asset classes. This can materially change risk-adjusted returns of a portfolio and build wealth over the long-term for an investor.

Investors hence need to look at mutual funds as a means of achieving their financial goals over the medium to long term. There are many schemes which have emerged multi-baggers in the long term – a multi-bagger, here means that a scheme’s net asset value grows?multiple times. Remaining invested for long can be especially rewarding for patient investors.

After a joyous Diwali celebration, it is time to get back to the serious business of investing. It is time to start one more systematic investment plan. For aggressive investors a multi-cap fund, especially from the house of Axis, HDFC or WhiteOak will work. For less aggressive ones an SIP in multi-asset schemes of Nippon, UTI, or DSP should be considered. For someone with a lumpsum on hand, 20% of the money can be deployed at this moment in a multi-asset fund and the rest can be initiated through a systematic transfer plan over the next three months.

Investors must bear in mind that investing is all about ignoring noise and staying focused on one’s financial goals. As the world worries about an economic slowdown, it is time to think about cash flows and future financial goals. Without taking undue risks, investors need to keep investing in diversified mutual fund schemes instead of chasing the next Reliance or next Infosys. Disciplined investments are more likely to help accelerate investors’ journeys to their financial goals.?

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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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