Mutual Fund Investing: Does buying during collapse make maximum wealth?

The real test of investor maturity and tenacity begins now. Will we, our parents, uncles, aunts, siblings and friends continue to hold on even if the market remains choppy and erratic for the next several months? Will we push back the urge to press the redeem button? Will we continue our monthly SIPs?

As the retail investor looks to the future and ponders over the above questions, he/she is also looking at data. Run a screen on mutual fund performance over the last few years, and some staggering trends come to light. The numbers can stump the average individual at first glance, which is why the reasoning and context is very important. Let’s look at a fairly patient time frame of 5 years. Guess which funds have given the best returns during this phase? If your answer is equity, then you’re in for disappointment. Gold funds top the charts in terms of performance over the last 5 years with a return of 10.3 percent.

The next 4 best performing fund categories over the last 5 years are all fixed income funds – 10-year GILT funds, banking & PSU debt funds and long duration debt funds with returns between 7.7 percent and 9.4 percent. Now you’d wonder how equity funds fared during this time. The answer: not too great. Largecap and Multicap funds are up 1.7 percent on an average and midcap funds are up just 1.1 percent going by the annualised returns of the last 5 years. Smallcap funds have in fact given a negative 0.2 percent return since 2015.

If one looks at the last 3 years, the equity story is even more dismal with largecap funds up just 0.3 percent and midcap funds actually down 4.7 percent. Gold and debt funds again trump equity over the last 3-year period with just one category of equity funds – IT sector funds making it to the top performers tally.

Now investing is a long-term art. So let’s shift the time horizon to 10 years. Which are the funds that have done the best in the decade gone by? The picture here as well makes one think. Largecap funds have returned 6.7 percent at an average in the last decade. Multicap funds have done better at 7.8 percent and midcap funds score the best at a 10 percent CAGR return.

Interestingly, smallcap funds, at a category average level, have not managed to beat midcap funds in the last 10 years with average returns being 7.4 percent.

Now let’s look at returns from debt funds in the same 10 year period. Corporate bond funds and liquid funds have given an average return of 7.8 percent while dynamic bond funds have returned 8 percent.

These startling numbers can lead to a very obvious question – why take the risk of equity if debt is giving you similar or even higher returns over a decade?

Here’s where you need to pause and supplement data with context and  reasoning.

“There are lies, dammed lies, and then there are statistics!” quips Kshitiz Mahajan of Complete Circle Investments. He argues that the return analysis will be vastly different if we pick the time frame of February 2010 to February 2020 i.e the comparison before the COVID crisis hit markets.

“If I change the date from April 10, 2020 to February 14, 2020 and compare the last decade, then midcap funds have returned 11.5 percent and smallcap funds have done even better with a CAGR of 14.4 percent,” explains Mahajan.

The argument finds resonance with Radhika Gupta, CEO, Edelweiss Asset Management. “Looking at rolling returns is a much better way of judging a fund’s performance rather than considering point to point absolute returns. Rolling returns give a fair idea of performance without letting short-term market spikes skew the analysis,” says Gupta.

Point taken. But what about the more fundamental question of asset class performance? At a glance, the 10-year data gives the impression that debt has done better than equity over the last decade. While that may be optically true considering the time frame we are comparing, Mahajan argues that one must keep taxation in mind while comparing returns. “Net of tax, equity funds have still done better than debt as pre-2018 capital gains have been grandfathered whereas debt funds still attract tax at the slab rate with indexation,” says Mahajan.

Let’s also remember here a third important aspect. Debt funds aren’t exactly risk free. So for instance, the 8 percent return one sees in dynamic bond funds over the last decade, is accompanied by interest rate risk. Similarly IL&FS, Vodafone-Idea, DHFL and several other recent episodes have taught us that credit risk funds carry their own element of debt payback i.e credit risk. Thus the return on fixed income funds may not be as risk free and simple as a fixed deposit.

The last 10 years have been a very eventful ride for the Indian investor. The post GFC recovery, a current account deficit crisis, govt changes, trade wars, and now a never seen before pandemic. Through it all, one fact stands tall - the path to superior equity returns is neither straight line, nor risk free. But common sense as well as history tell us that the greatest wealth is made by buying during times of total chaos and collapse, and then simply having the tenacity of holding on for the next several years. So while you ponder over reams of return analysis and mutual fund comparison data with your financial advisor, perhaps it’s a good idea to first ask yourself the basic question – what kind of a person are you and what are your operational realities? What is your risk profile and what is your holding capacity? The answer will be perhaps the starting point for most things in life, including your financial future.