Can equity funds yield higher returns than direct equity from these levels?

Can equity funds yield higher returns than direct equity from these levels?

FY21 has been a paradoxical year for the equity markets. While the pandemic played havoc with economic activity across the world, stock markets showed a diagonally opposite behaviour. Amid the new highs scaled by the markets during the year, we are yet to see a sizeable and sustainable pickup in economic activity.

Green shoots are emerging and over the past two quarters growth is apparently coming back on a low-base effect and pent-up demand.

The domestic equity market continues to be riding higher with intermittent bouts of decline. The Sensex has gone up from 37,000 in late September 2020 to trade around 50,000 level currently. The scorching pace at which the market has scaled all-time high levels has been perplexing to many retail investors. India’s market-cap-to-GDP ratio was now at a 20-year high of 104 as on March 18, 2021. The ratio was at 56 in March 2020, which was the sharpest decline in it. Even on price to earnings (PE) ratio, the current valuations are way above historical averages.

However, one must realise that the earnings are currently depressed due to the extraordinary pandemic event and that earnings are normalizing as we can see in the last two quarters. The markets being a future discounting machine, is possibly betting on strong GDP growth and earnings revival in the next 1-2 years.

Despite such a meteoric rise in equities in the last 6 months, mutual funds have witnessed a different scenario. Investors have been cashing out of MFs selling their equity funds. There has been some respite on the debt side.

In fact, flows into open-ended debt funds turned positive in January 2021, while equity schemes have been witnessing outflows for over nine months now.

With valuations at such high levels, retail investors with little time to study and follow the markets by the tick need to turn to mutual funds to ensure rational returns at reasonable risk, rather than taking higher risks all by themselves. Also, selecting the right stocks by measuring the risk involved requires a blend of research and experience that experts tend to have.

Also, a mutual fund portfolio generally offers adequate diversification across stocks and sectors. Again, anecdotal evidence shows that retail investor tends to hold mutual fund investments for a much longer period than individual stock holdings.

A combination of all these factors increases the probability of a mutual fund investment yielding higher returns over medium to long term than individual stock investments by a normal retail investor.

Another simple strategy for the retail investor to follow in such volatile times is to use the SIP route. An SIP requires a monthly commitment to save and invest. In this case, a predetermined amount automatically gets deducted from your bank account and invested in the mutual fund schemes you choose. It lets you invest at both the ends of the spectrum – high and low levels, resulting in a weighted average return over time.

SIPs benefit investors during market downturns because one can buy more units at a lower price. They are perfect for new investors and those who have a consistent cash flow. With elevated valuations and the markets hovering around their all-time high levels, looks like mutual funds hi sahi hai for retail investors as of now.

(Prasanna Pathak is Head of Equity & Fund Manager at Taurus Mutual Fund. Views are his own)

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