Inflows chase performance

It is no coincidence that equity funds saw their largest net inflow to date, in March 2000 — just after the peak of the technology stock boom, which saw the BSE Sensex touch its life-time high of over 6000 points in February 2000. Net inflows into equity funds (sales minus redemptions), at Rs 2,595 crore in March 2000 set a record that is yet to be breached, even in recent times.

Fund flows appear to have chased good performance from equity funds, which notched up an estimated holding period return of 40 per cent in the five-month period between October 1999 and February 2000.

Unfortunately, inflows into equity funds peaked just as the markets and fund returns did. In the very next month after the record inflows, equity funds as a class, saw their net asset values shaved off by an estimated 16 per cent.

This is not an isolated instance of investors taking a fancy to equity funds in an upbeat market.

Net inflows into equity funds also picked up for a short period in January/February 2001, when the Sensex briefly flirted with the 4200 levels, after a prolonged bearish phase.

Recent trends also show that mutual fund investors have not yet kicked the habit of hopping on to equity funds in the advanced stages of a bull market. Net inflows into equity funds have picked up significantly since February 2003.

But the bulk of the inflows have come in between July and September 2003, after equity funds had registered holding period returns of around 20 per cent in the preceding two months.

Few takers in a bear market

On the other hand, over the past four years, investors appear to have missed out on obvious opportunities to buy into low index levels. Equity funds, for instance, found few takers when the markets crashed after 9/11.

Since the crash was triggered by a one-off event, Sensex levels of between 2800 and 2900 points in September/October 2001 would have been a good opportunity for investors with an eye on the long term, to start building a nest-egg in equities.

Yet, equity funds experienced a marginal net inflow of Rs 58 crore in September 2001 and actually saw a net outflow in October 2001.

Similarly, net inflows were a trickle in September/October 2002, the second occasion over the past four years when the markets retreated to the 2900 levels.

This suggests that the bulk of investors in equity funds are of the fence-sitting variety.

Few investors appear to take advantage of a bear market to add equity funds to their portfolio, when there may be a fairly long wait before returns begin to flow in. But large numbers of investors appear to be tempted by the prospect of quick gains, once equities take wing.

Slow to pull out

If investors wait for concrete returns before they enter equity funds, they are also equally loath to liquidate their investments when the market tanks.

The pattern in fund flows shows that equity funds have seldom suffered from redemption pressure in the immediate aftermath of a crash in the indices.

The tech stock collapse of 2000 is a good instance. After notching up positive returns in every month between October 1999 and March 2000, the indices dropped 12 per cent in April 2000. But this did not cause any sharp spike in the pullouts from equity funds.

In fact, equity funds continued to witness net inflows for a full five months after the first signs of the meltdown became apparent. It was only in September 2000, when the Sensex had retreated 25 per cent from its peak, to 4000 levels that equity funds saw a spike in net outflows, at Rs 922 crore for the month.

From a broader perspective, it is certainly healthy that investors do not pull out of equity funds in a panic at the first whiff of a reversal in trend.

Any redemption pressure on equity funds could fuel a downward spiral in equity values. But it may not be a practical strategy for investors who have a holding period of five years or less.

If investors enter the equity market at its most buoyant phase, they may need to take a fairly active approach (by cutting losses and re-entering at lower levels), so that the investment earns them a reasonable return at the end of their holding period. By and large, the above trends suggest that when it comes to investing in equity funds, investors have displayed a rather poor sense of timing.

Not only do more investors enter equity funds in a bull market, they also seem to stay away from equity investments in a bear market.

Profit-booking picks up too

If buoyant phases in the market set the cash registers ringing for equity funds, it also triggers a pick-up in redemption activity for equity funds.

For instance, in each of the three bull phases in the stock market between 1999 and now, the gross redemptions from equity funds also picked up during the buoyant phases; though not to the same extent as gross sales.

This shows that a significant section of investors do keep track of performance and take advantage of buoyant markets to book profits on their earlier investments. This trend has been particularly strong in the recent rally.

As equity funds sales have picked up from Rs 366 crore in April 2003 to Rs 2,362 crore by September 2003, there has been a marked increase in the redemption numbers as well, from Rs 161 crore to Rs 1,840 crore.

But, going by the significant pick-up in net inflows, it is clear that the investors leaving equity funds are outnumbered by those making fresh investments.

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