Markets test investors' patience, so play the waiting game for rewards

Equities perform in short bursts. Make sure you are not out of the market on those crucial days

On September 20, Finance Minister Nirmala Sitharaman announced a reduction in corporate tax rates. A day ago, on September 19, the Nifty had closed at 10,704 and its one-year return stood at -4.71 per cent. The announcement galvanised the equity market. The Nifty closed at 11,600 on September 23, a gain of 8.37 per cent within two trading days. From a negative -4.71 per cent, its one-year return rose to 4.08 per cent. Imagine the loss to your portfolio if you were not invested in equities on those two crucial days – September 20 and 23. It is owing to the market’s propensity for such rapid upward moves that old-timers keep repeating the following mantra: “Time in the market is more important than timing the market.”  

Morningstar study: Morningstar has conducted studies in the US and Indian equity markets that drive home this point nicely. In the US, Morningstar analysts compared the performance of large-cap active funds with the category benchmark over a 15-year period. The outperformance of each fund was arranged in descending order. 

Then the outperforming months’ returns were removed one by one, starting from the top. There came a point when the fund’s performance dipped below that of the benchmark. The months that had been removed until that point were termed “critical months” which accounted for the fund’s outperformance. The study showed that on average, only 5 per cent of the total months accounted for funds’ outperformance. 

 

Morningstar then conducted a similar study for the Indian market – both for stocks and for diversified equity funds. The performance of BSE 100 stocks was compared with that of cash (liquid fund return was used as a proxy for cash). Active funds’ returns were compared with those of the category benchmark. The study showed that for the period July 2009-June 2019, outperformance came from only eight of 120 months for both stocks and funds. 

Only 6.7 per cent of months (it is the average number) accounted for all the outperformance. “The study highlighted that you may well have stay invested in a fund for 112 months. But if you were not there during those critical eight months, your returns would not have surpassed the benchmark,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India. 

Equity market returns are not steady but lumpy. “This is because markets react to incremental changes—positive and negative—and the news gets discounted in stock prices,” says Harsha Upadhyaya, chief investment officer-equity, Kotak Asset Management Company. He adds that it is difficult for any investor to anticipate these changes and position himself suitably to benefit from them and it is almost impossible to do so over the long term. This holds true as much for veteran fund managers as for retail investors. “This is why we avoid keeping cash beyond a certain level in our equity funds,” says Upadhyaya. Adds Nikhil Banerjee, co-founder, Mintwalk: “Since it is impossible to anticipate when those critical days of high returns will arrive, investors can only benefit from them by holding on to their equity investments for the long term.” 

Avoid market timing: One manner in which this tendency manifests itself is that investors stop or postpone the renewal of their systematic investment plans (SIPs) in equity funds in bad markets. This is happening within the mid- and small-cap segments currently. “Many retail investors operate only on the basis of past performance. When past returns begin to look poor, they stop their SIPs. Avoid doing so. The very purpose of SIPs is to help you deal with, and even gain from, volatility,” says Upadhyaya.   

      

Avoid switching funds: An investor sees a fund doing well over the past year and invests in it. Six months or a year later, the fund’s performance tanks. Meanwhile, he sees another fund doing well, so he sells his current fund and hops on to the other one. This vicious cycle goes on until the investor realises his mistake. 

Investors often enter funds without understanding their nature and riskiness. Funds can be large, multi, mid or small-cap oriented. In some years the large-cap segment does well and in others, the mid- and small-cap segment. 

Similarly, fund managers follow one of the three styles of investing – growth, value or bl­end. Growth-oriented managers invest in stocks that have high earnings potential. They are prepared to pay a high valuation for them. Value-oriented managers like to invest in sto­cks that are sound fundamentally but may be down and out in the current market. They opt for them because they are attractively valued and the fund manager believes the company will turn around in due course. Finally, there are fund managers who follow a blended strategy such as GARP (growth at a reasonable price). While they like to invest in stocks that ha­ve reasonable earnings growth prospects, they are not prepared to pay too high a valuation. No investment style works in all markets. There are times when growth investing does well and others when the value or blended style works. “Investors need to be patient with their fund manager if market conditions do not favour his investment style,” says Belapurkar. 

Look up the style sheet of funds and choose a mix of funds spread across its different quadrants. Select quality fund managers and then stay invested with them for at least seven years so that you are able to garner reasonable returns over a market cycle.

Don’t review portfolio too often: Being hyper-active in managing your fund portfolio can prove counter-productive. As the Morningstar study shows, funds outperform their benchmarks in short bursts. They barely keep up with them for the rest of the time. Checking the equity portfolio too often can lead to mistakes. “Reviewing the portfolio once every six months, or even once a year, should suffice,” says Banerjee.