Equity mutual funds are the preferred way for an investor to grow their wealth long term while sticking to investment best practices.
By Prateek Mehta
For a normal investor, these are the times when the belief in equity markets is shaken. There is a certain method of selecting financial instruments for investments at any time, market crisis or not. You first figure out what you are investing for, the time frame, your savings available to plough towards that objective. Next decision is on the asset class and the sub-asset class that makes sense based on the time frame and finally the actual investment instrument.
Equity has a history of beating inflation over a 7 year or greater period, consistently. Whether it is the Indian stock market for the last 40 years or the US markets for over 100 years, equities have a proven track record of beating all other asset classes. When you bet on equities, you bet on human enterprise, ambition and aspirations.
Most other asset classes have done this inconsistently at best or rarely. For most long term objectives and for generally growing your savings to stay ahead of inflation, equity has been the asset class of choice.
What should you choose?
While mutual funds in India have been around for decades, India saw more retail investments via the direct purchase of shares simply because the overall participation in equity markets by retail investors was low and awareness of equity mutual funds poor till the early 2010s.
The reason why mutual funds exist is to make retail participation in the share markets simpler and more accessible. This is quite important to remember. We will talk about how mutual funds make this happen, later in the article.
Stocks are volatile as they are market-based and they are traded every day. Their prices move based on hundreds of factors and not all factors can be factored in all the time by most investors. From whether a company’s balance sheet is clean and honest to predictions of revenue growth given particular legislation or global trend, the sheer variety of influencing factors is mind-numbing.
This has only become more complicated with the advent of algorithmic trading and associated technologies like machine learning which deploy sophisticated processes to buy and sell equities and derivatives.
For the retail investor wishing to invest in stocks of companies, stock selection has become more difficult even though the amount of information he or she has at their disposal has grown a thousand-fold with multiple websites providing everything legally available about the price of a stock and the company’s fundamentals.
Most retail investors, such as you and I, simply do not have the time to analyse, create an investment thesis, test and improve it on an ongoing basis. This requires effort, discipline and frameworks that will work irrespective of the emotional impact of market conditions on you.
In the 90s, finding stock specific information required reading through multiple annual reports and news magazines that specialised in the stock markets. The world wasn’t as lightning fast as it is today where entire indices can see intraday moves unheard of earlier.
During this current pandemic, markets are seeing falls that are so broad-based that holding a winning position is next to impossible. Traders, thinking of timing the market, are getting surprised by the sharp falls and reversals, as was seen on the 19th of March.
Stock selection for the long term investor
Wealth creation in equity markets is, for most retail investors, a process that unfolds over decades. Our current long term growth rate assumption for equity is 12 per cent annualised. The indices themselves have returned 14 per cent to 16 per cent in the past. An individual portfolio of stocks could have grown more or less than this depending on which companies one was invested in.
Being invested in the right companies that represent the best of the economy is not easy. Companies that ruled the markets once went bankrupt later, while there are others which have been part of the indices for its entire history and these stocks have grown investor wealth multifold. The Yes Bank crisis shows just how much the fortunes of a company can change. That story unfolded while the Yes Bank stock was still part of the Nifty50!
Being part of the winning list is far easier when you invest via mutual funds whose full-time job it is to look for such companies. Odds are that a mutual fund will find out such companies far more consistently and invest in them than most retail investors trying to invest in stocks on their own even if they are armed with all the apps and news sources that are available these days.
It is simply common sense for those without professional expertise in the markets to engage professional investors on their behalf. Equity mutual funds do this at the lowest cost and ensure that the retail investor has to make the minimum number of decisions.
In a crisis
The current COVID-19 led market crisis might vitiate the environment for weaker companies. The core business might struggle and they might struggle to maintain growth and earnings. The second-order effects of such events and the lockdown are hard to ascertain and the full extent of the impact will become clearer only in the coming months.
In such uncertain environments, selecting stocks is nothing short of challenging. Mutual funds are much more likely to make better decisions about what to do because they have been monitoring these events for a while and have experience of dealing with market crashes.
Those who want to invest in equity as an asset class are better off trusting good funds to do what is smart at this stage rather than trying to bet which stocks will be the multi-baggers post this crisis. The crisis of 2007-08 hit the banking sector hard but the best banks went on to become perhaps the most valuable part of the indices today.
This crisis will also have its winners and losers. For an individual investor, unless you are an expert at the stock selection and have a process that delivers consistent returns, stocks are not the best way to invest in equity. Mutual funds prune their portfolios depending on the need and add better companies to their portfolios. The same is much more difficult to execute efficiently for retail investors.
Hence, equity mutual funds are the preferred way for an investor to grow their wealth long term while sticking to investment best practices that are much more likely to lead to favourable outcomes.
(The author is Chief Business Officer – Scripbox)