Latest data on money flows into equity mutual funds from the Association of Mutual Funds of India (AMFI) have popped the happy bubble in the mutual fund community.

In December 2018, net inflows into equity-oriented funds at ₹4,487 crore were 60 per cent lower than the November flows of over ₹11,000 crore. This is also the lowest monthly figure recorded since demonetisation opened the floodgates for retail flows into mutual funds in end-2016. Attributing this dip to year-end holidaying doesn’t cut much ice because last December saw equity funds draw in ₹25,800 crore.

So, what’s caused the dip? Is it temporary, or a sign of investors getting tired of equity funds? A deeper dive into the AMFI data provides some answers.

No crash, but a gradual dip

Gross inflows for equity mutual funds are far more useful to gauge investor appetite for equity funds, than the widely-used data on net inflows. After all, net inflows into funds are just the arithmetic result of one set of investors pouring in money while another set is pulling out in any given month.

Gross monthly purchases of equity-oriented funds over the last two years show that domestic investors’ purchases didn’t suddenly fall off a cliff in December 2018. They in fact peaked in January 2018 and have been on a gradual slide since.

Here, we add up data for pure equity, arbitrage, tax saving ELS and balanced funds (65 per cent equity allocation) to analyse investor behaviour in equity-oriented funds.

The data show that investors made their biggest splurge on equity funds in January 2018, with gross purchases of over ₹58,650 crore. This moderated to ₹29,000-35,000 crore between April and October 2018 before sinking to ₹23,000-25,000 crore in the last couple of months. The bulk of tax saving (ELSS) investments are made in January-March, and so one can expect a ₹2,000-3,000 crore bump-up to the numbers in the rest of the fiscal.

But even accounting for this, retail flows into equity funds seem to be pretty closely tracking the Sensex graph. In 2017, owning Indian equities was a one-way street with the BSE Sensex climbing without a pause from 26,000 to 34,000-plus. But 2018 saw markets subjecting investors to an up-and-down ride. The Sensex peaked out at 36,000 in end-January, plummeted below 33,000 in March, jumped back to over 38,000 in August and has been correcting since.

It may not be textbook behaviour for investors to make record equity purchases when indices are at highs, and to go all cautious when they are heading for lows. But then, the phenomenon of retail investors chasing past returns is prevalent even in the most developed markets. In India, past cycles have shown that retail flows into equity funds typically peak when their past one-year and three-year returns are sky-high. Presently, one-year returns for most equity funds are in the red. That will have to change for equity flows to revive.

Pure equity wasn’t worst hit

But the surprise is that it is not pure equity funds, the most buffeted by stock market swings, that saw the maximum shrinkage in inflows. It was arbitrage and balanced funds.

Gross purchases of pure equity funds fell 33 per cent in April-December 2018, compared to the same period in 2017. Despite dicey markets, ELS funds attracted 6 per cent more money this year. But purchases of balanced funds shrank by 52 per cent in April-December 2018. AMFI has begun disclosing separate data for arbitrage funds only from April 2018. But judging by the net flows, arbitrage funds have seen a more than 90 per cent dip in their patronage.

That balanced funds, which are less volatile than pure equity funds, have had investors fleeing, suggests that the category was mis-sold quite heavily in the last couple of years. Post-demonetisation, many risk-averse investors were lured to make a big switch from bank deposits to balanced funds with misleading promises of double-digit returns and tax-free monthly dividends. But recent dents to balanced fund NAVs have exposed their risky nature, disillusioning investors.

Arbitrage funds, which take positions in cash and stock futures for debt-like returns, attracted droves of HNIs in 2016-17 mainly for their tax-free returns. But with the 2018 Budget imposing a 10 per cent long term capital gains tax on all equity funds, the tax edge has been whittled down. HNI investors therefore appear to be flying the coop. On a net basis, balanced funds saw their inflows dip from ₹70,312 crore in the first nine months of 2017 to just ₹12,075 crore this year. Arbitrage funds saw their net flows shrink from ₹26,272 crore to a mere ₹1,668 crore. The dip in net flows for pure equity funds, from ₹99,440 crore to ₹81,211 crore was much milder.

This goes to show that investors who bought equity funds for all the wrong reasons were the ones that were most spooked by market gyrations and tax changes.

No panic redemptions

While investors did moderate their fresh purchases of equity funds in a see-sawing market, the good thing is that they didn’t rush to redeem their older investments.

AMFI data on gross pull-outs from equity funds show that the months that saw the highest redemptions in the last two years, were December 2017, January 2018, March 2018 and August 2018.

Investors seem to have rushed to book profits on their equity funds in March last year to avoid paying the new capital gains tax, effective April 1. But for that episode, redemptions peaked whenever the Sensex hit new highs. The votaries of long-term investing may not like this retail tendency to book profits on equity funds. But given the whimsical nature of the stock market and the super-heated valuations at which stocks were trading, the decision to take money off the table was a sensible one.

Gross redemptions from equity-oriented funds, which peaked at over ₹42,000 crore in March 2018, have since halved to ₹20,200 crore in December 2018.

What’s ahead

Investor behaviour so far suggests that should the Sensex continue its directionless meanderings this year, one can expect balanced and arbitrage flows to mostly dry up. ELS funds may continue to receive steady flows and pure equity funds may get away with a 20-25 per cent dip in inflows. Redemptions are unlikely to pick up in falling markets.

Though industry insiders argue that monthly flows through the SIP route, at ₹8000 crore now, will hold rock-steady even in a falling market, this appears unlikely. Monthly SIP flows were at ₹3,880 crore two years ago and well over half of the current SIPs have been kicked off in rising markets. So, if these SIPs deliver losses or underperform lumpsum investments, stoppage of SIPs and fewer sign-ups cannot be ruled out.

Given India’s demographics, every bull market inevitably draws in hordes of newbie investors who haven’t experienced a down-cycle. They are bound to develop cold feet if markets misbehave.

Based on these assumptions, a ballpark calculation indicates that net equity fund inflows could still hold up at ₹1-1.2 lakh crore in the year ahead. This isn’t a bad number given that just five years ago, equity funds were struggling to meet net redemptions of over ₹12,000 crore. But this is provided the Sensex doesn’t launch into a 2008-style correction, in which case all bets would be off.

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