Last year, returns from mutual funds were lower than those generated from fixed deposits, despite the Sensex and the Nifty being at higher levels compared with previous years. How much more can we expect from the market, given the already high PE (price-earnings) levels? Is too much inflow into mutual funds resulting in managers chasing the same set of large- and mid-cap stocks? Where are we headed? I am 40-plus.

PR Ravindran

The Sensex and the Nifty — the two bluechip indices — have been up 2.5 and 7.2 per cent, respectively, over the past year. Indeed, 2018 was a very volatile year, and indices — especially those tracking mid- and small-caps — were hammered down and are still mostly in the deep red if one-year returns are measured. Some benchmarks are down 30-40 per cent from their peak in early 2018.

You are right in a way when you say MF returns were lower than FD returns last year. But equity returns trailing those of fixed-income instruments in certain years is quite natural in any market cycle. The returns from market-linked products are not linear.

In the long term, equity is still reliable. The Sensex has delivered more than 16 per cent annually in the past 10 years, easily beating inflation. The best of equity funds have delivered 19-20 per cent in this period.

In contrast, you would not have been able to generate more than 8-9 per cent on a pre-tax basis from fixed deposits in most of the last 10 years.

It is true that index valuations are expensive at over 20 times trailing earnings. But the valuation multiple does not present the complete picture.

Only a handful of stocks (7-8) were leading the market rally from late 2017 and much of 2018, and into this year as well. Most firms in the Sensex and the Nifty were reporting profit declines earlier, so the PE multiples look stretched. In the mid- and small-cap space, too, most firms’ financials took a hit. With banks reporting high non-performing assets, the liquidity situation worsening and with NBFCs facing the crunch with some of them defaulting, the overall sentiment is weak. Fund managers cannot hold exposure to individual stocks beyond 10 per cent of the portfolio. So, they can’t load up on one set of stocks that are winners. Thus, the overall portfolio might suffer.

Also, after SEBI made classification of schemes based on market capitalisation of stocks water-tight, it has become difficult for managers to manoeuvre outside their funds’ rigid mandates.

With the sharp fall in mid-cap stocks and the narrow rally in a few select large-caps, MFs across categories underperformed their benchmarks. With inflows into MFs steadily rising, fund managers are forced to chase the same set of stocks of large- and mid-cap companies.

Looking ahead, it does appear that in the large-cap category at least it is going to be increasingly difficult for fund managers to outperform or even match benchmark returns. Instead, you can choose index funds and exchange-traded funds for the large-cap category alone. But while investing in small- and mid-cap funds, there is still ample scope for active investing as there is a reasonably large universe to tap into.

Timing, too, is becoming important while entering and exiting markets. But most investors, especially retail, will find it challenging. So, SIPs are still the best route for retail investors to participate in the markets. Also, while investing in equity funds, a minimum of 5-10 year horizon is necessary. Anything less would mean you would be better off investing in balanced or debt funds.

As indicated earlier, despite lots of volatility and heavy corrections, equity should form a major part of your portfolio — especially as you are still in your 40s — for above-average, and benchmark- and inflation-beating returns.

Send your queries to mf@thehindu.co.in

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