The March data on mutual fund flows offers some good news amid the gloom and doom on the economy. Despite the escalating Covid-19 crisis and a 30 per cent decline in stock indices between February and March 2020, Indian investors seem to have kept faith with equity funds.

AMFI estimated gross subscriptions to open-end equity funds at ₹30,109 crore for March 2020, up 21 per cent from February and 9 per cent from March 2019. It praised retail investors for turning this crisis into opportunity, by committing a record ₹1 lakh crore into equity SIPs in FY20.

If numbers hold up in the coming months, they would go to show that investors have truly imbibed all the industry’s messaging about staying the course in tough times, to reap the rewards of equity investing in the long run.

But then, this also begs the question: What is the mutual fund industry, and the advisory ecosystem that supports it, doing to ensure that investors who put faith in equity products get a good return experience in the long run?

Sizeable losses

In the past, loss containment in bear phases has always been a challenge for Indian equity funds. This bear phase has been no exception.

Despite unabated inflows, aggregate equity assets managed by mutual funds shrank from ₹9.75 lakh on January 31 to ₹7.36 lakh crore by March 31, 2020, straightaway hinting at a wealth erosion of ₹2.4 lakh crore for investors. Investors have effectively lost a fourth of all the money they invested in just a two-month market fall.

The average equity fund suffered a loss of about 25 per cent between February 19 and April 2020, with the worst-performers shedding 30-40 per cent. Of the 310 open-end equity schemes in operation, 128 fared worse than their benchmarks. The proportion of funds lagging their benchmarks (40 per cent) was the same as in the last market crash from January to October 2008, though the losses then were far higher.

While seasoned investors who’ve lived through past market cycles may be able to weather these losses, what of new investors who’ve stepped into equities in recent years? Let’s not forget that 60 per cent of the current equity fund assets and more than half of the monthly SIP book have been added in the last four years.

So, what can fund industry, and the ecosystem that supports it, do differently to deliver a better return experience to investors?

Fill the allocation gap

Financial studies tell us that the asset allocation plan followed by an investor matters far more to her portfolio returns than owning the right products. But it is doubtful if this message has hit home with Indian investors.

Most investors seeking expert advice ask for inputs on fund choices, paying little heed to the steps before it. Many distributors (save for the limited set of full-service advisors) guide clients on the funds to buy, expecting them to formulate their own asset allocation plans. Fund rating platforms help investors identify top performing funds with limited focus on asset allocation. Direct investors, who now account for 13 per cent of retail equity assets, dive straight into fund choices without any preliminaries.

It would make a big difference to the investor return experience, if AMCs encouraged first-time investors to explore hybrid funds with a ready-made asset allocation instead of pure equity funds as their first step. Given that debt, too, yields respectable returns in India, funds with an 80-20, 60-40 or even a 50-50 mix of debt and equity can deliver returns that are pretty close to equities, with much lower downside.

But an obsession with equity tax breaks has prompted the industry to focus mainly on pure equity and aggressive hybrid funds, while conservative hybrids and dynamic allocation funds are sold as niche products.

Filling the asset allocation gap is an essential first step to ensuring that retail investors pouring money into equity funds bite off only what they can chew.

Take cash calls

“Time in the market is more important than timing the market”. Mutual fund honchos love to spout this axiom whenever they’re asked if it’s the right time to invest. This is also the argument that has been used to convince over three crore retail investors that SIPs are a magic pill for great investment results.

But as investors who have been running SIPs for the last three and five years can tell you, SIPs don’t guarantee positive outcomes in all kinds of market conditions. If you insert SIP into equity funds in a steadily rising market, your acquisition cost instead of being averaged down gets averaged up, diminishing your returns.

Given that the fund industry has convinced investors to pour money into equities come what may, the ball is now in the fund managers’ court to ensure that this money is not deployed into super-heated markets. Building the flexibility to hold cash for extended periods into an equity fund mandates can help them deliver a better investment outcome to SIP investors. Hanging on to cash when stocks appear over-valued and deploying it when valuations correct can help avoid severe downside.

While tactical cash calls based on market direction can backfire, those based on valuation can help deliver a good product for investors who are not looking to shoot out the lights but are merely trying to beat an FD. AMCs must lean on SEBI to permit a sub-category of equity funds which use cash calls to smooth out returns for loss-averse investors.

Regulate flows

Investors tend to double down on a category when its past returns are in double-digits, and stay off it when trailing returns look bad. For a better return experience, they should be doing the opposite.

Advisors can play a big role in keeping investors off hot categories and nudging them towards out-of-favour ones, to improve their experience. Rating platforms must stop assigning high weights to recent returns. But Indian AMCs need to do their bit too, by regulating inflows into over-fancied styles and categories where it’s a challenge to find deployment opportunities.

In the recent bull market, several small-cap funds gated inflows citing lack of opportunity, but hardly any large-cap or multi-cap manager took this call. This is despite a clear lack of earnings growth in the market, which led to many managers privately complaining about a shrinking universe and expensive ‘quality’.

In developed markets, it is common practice for fund houses to assess the carrying capacity of a strategy at the time of its launch and to announce a soft close of a popular fund if it attracts unmanageable flows. Domestic funds across the spectrum must adopt this practice.

Finally, most of the communication from the Indian mutual industry today revolves around sticking with SIPs in volatile times and buying calls on fund categories. This is perhaps a legacy of the times when retail investors viewed equity funds with extreme suspicion and had to be coaxed and cajoled to invest in them.

Now that Indian investors have been comprehensively converted to the equity cause, it is time for both the industry and its fund managers to change track. Industry ad campaigns and fund manager communiques need to focus on the need for appropriate asset allocation and the kinds of investors who must avoid equity funds. Warning investors off pure equity funds when the timing is inappropriate and sell calls on over-fancied strategies, need to become an essential part of the industry’s messaging.

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