(Photo: iStock)
(Photo: iStock)

Mutual fund investors riding out market volatility through smart moves

  • The driving force for mutual fund investments are SIP flows, which have averaged 8,000 cr for the 12 months till Aug
  • Investors are moving out of the riskier segments of credit risk funds into others such as corporate bond funds

Mumbai: Retail flows into equity mutual funds have ebbed and flowed with the broad moves in the markets. Flows rose when the markets did well and fell when the markets corrected. While the broad trend has remained the same since the correction in equity valuations started in early 2018, it is different this time. Even though one-year returns show a meaningful erosion in portfolio values, mutual fund investors have resolutely continued with their investments.

In August, net inflows into equity mutual funds stood at 9,215 crore, the highest in the past five months. This is despite the fact that one-year returns in August were the weakest in over three years.

“Investors are showing maturity. Rather than looking at current market conditions or past returns, they are looking at future prospects," said Harsha Upadhyaya, chief investment officer (equity) and senior executive vice president at Kotak Mahindra Asset Management Co. “In earlier years, when volatility increased, people pulled out of equities or shifted out of risky segments. A change is being seen among investors now."

The driving force, of course, are the inflows into steady systematic investment plans or SIPs, which have averaged about 8,000 crore for the 12 months till August, or about 20% more than the average for the previous 12 months till August 2018.

In April and May, when net inflows fell to 4,230 crore and 4,970 crore, respectively despite SIP flows of about 8,200 crore each month, it obviously meant there was an increase in redemptions. But with net inflows surpassing the gross flows through SIPs in August, it shows that inflows through lump sum investments have now exceeded total redemptions as well.

It’s early days, though, since lump sum investors are just coming back. Net inflows are nowhere near the peaks of 2017.

Even so, there has been a steady increase in the number of folios as well, a rough proxy for the number of mutual fund investors. The number of folios with equity fund holdings increased from 58 million in April to 59.8 million by August.

The mutual fund industry is in uncharted waters, where it continues to receive large inflows at a time when the markets are volatile.

There has been some criticism among market participants that this results in adverse portfolio decisions.

Recently, a domestic portfolio manager, Porinju Veliyath, tweeted, “A national loss to use public SIP money to give exit to frustrated FPIs from Top-15 at super-rich valuations!"

(Graphic: Paras Jain/Mint)
(Graphic: Paras Jain/Mint)

The reference is to the tendency of the industry to increasingly buy the largest stocks in the market in terms of market cap, at a time when foreign portfolio investors were exiting positions in these stocks. Data from Value Research shows that allocations by mutual funds to so-called giant cap stocks, which constitute the top 50% of total market capitalization, rose to 59.7% of assets under management in August, up from 56% a year ago. This is after excluding funds that solely invest in mid- and small-cap stocks as per their investment mandate.

The worry is that the economic slowdown may raise the risk of investors overpaying for assets, if equity prices continue to correct.

The flight to safety through the purchase of giant-cap stocks by fund managers is somewhat mirrored in purchases of debt schemes as well. Investors are clearly moving out of the riskier segments of credit risk funds into others such as corporate bond funds, and banking and public sector undertaking (PSU) funds.

While returns in the latter are relatively low, so too is the risk. This implies the latter’s safer risk-adjusted returns have been a fundamental draw for investors and the mutual fund sector.

Credit risk funds have seen an outflow of 13,784 crore between April and August, as against an inflow of 11,324 crore in corporate bond funds and 15,656 crore in banking and PSU funds. Banking and PSU funds invest in bond papers of PSUs.

It’s heartening that the volatility in the equity markets and the many defaults in the debt markets haven’t resulted in a large exodus by investors, but rather some smart manoeuvring.