It was in last September that the Lehman Brothers went bust, almost taking the world?s strongest economies down with it. Then followed the debt fund crisis in October, which despite not being associated with the equity did have its effect on the markets. 2008, in many ways, was a forgettable year. But thankfully, a better part of 2009 has been good for the markets and investors. The sun has been shining brightly for the past six months and the market benchmarks have recovered well from the nadirs seen in March.
Not surprisingly, mutual funds have taken full advantage of the recuperation as well. Out of the 260 equity funds, a good 120 of them have posted gains of over 100 per cent in the past six months. A smaller bunch of about 40 funds have done even better with gains of over 120 per cent. But what is really interesting about these funds is that the top gainers are the ones that were languishing at the bottom during the downturn. These are the same funds that had soared during 2006 and 2007, only to drop frantically in 2008. And they are back at the top again.
While this phenomenon is uncommon to mutual funds, there have been stocks that follow such patterns. They are known as momentum stocks. Such stocks ? and such funds ? ride the wave of market resurgence but fail miserably when markets flounder. In simpler words, such stocks create a lot of noise when the going is good, but when things turn for the worse, they fall without even a whimper. Such stocks are the favourites of a certain set of investors who chase performance. Like the stocks, these investors also make a lot of money in bull runs. But in bear phases, if they haven?t been careful about setting, resetting and obeying stop loss limits, they end up with mammoth losses.
It goes without saying that such stocks and funds should be avoided, particularly the funds. However, human nature ensures that that?s not the case. Mutual funds investments are made with a long-term outlook. An investor invests in a fund so that he doesn?t have to worry about the market?s gyrations. As long as he has his goals in place, he shouldn?t be concerned about the short-term losses or profits of his investments. But an investor is a human after all, who invariably ends up chasing performance. A recent hot performance comes with a high risk, but that fact is almost always overlooked.
For such a problem, the solution is to treat such funds as momentum stocks. Invest in them in small amounts, without making them a portfolio?s core holding. Instead of indentifying and tracking momentum stocks, invest in momentum funds. The trick is to set stop loss triggers. For example, set a stop loss for 10 per cent. Once the fund goes up by 10 per cent, reset the stop loss trigger to the new NAV. This way, you will be fulfilling your inherent desire to chase performance and at the same time, by investing in a fund you will be partly disassociated with high risk.
Of course, as far as I am concerned, I still believe in the conventional manner of investing. Opt for a good fund and stick to it for the long-term. An annual evaluation should suffice.
?The author is CEO, Value Research