Indian markets are starting to correct and the pain is being felt in mutual funds of different categories. Over the past three months, small-cap funds on average have dropped by 4.7%, mid-cap funds by 1.8% and multi-cap funds by 0.7%. The correction looks like is just beginning after a powerful show in these categories over the past 3-5 years. This has triggered interest from those who were waiting for a correction to buy and those who have already bought and are now sitting on poor returns.
Is this a good time to invest in equity mutual funds? It is difficult to answer this question because there are no clear signs of undervaluation or a market bottom. Nor can one say that this is a market top. The market’s future direction is anyone’s guess. However, there are a few measures you can take to protect yourself from panic redemptions if markets fall. Here they are:
- Close-ended funds
Close-ended funds open for subscription for a few days and then mature after a few years, usually 3-5 years. Their managers do not have to face constant redemption pressures like open-ended funds and they can potentially take better investment calls. On the other hand, close-ended funds are arbitrarily timed. If the market corrects for 3 years and then rallies sharply in the 4th year, a three-year close-ended fund will not be able to capture this. It will ‘terminate’ in three years and completely miss the rally.
Close-ended funds thus have their advantages and disadvantages but one advantage is their very nature. You cannot exit them during their tenure except by selling them on the stock market where liquidity for them is poor. You are thus forced to stay invested and you may be able to reap the rewards of patience.
The NPS or National Pension System is geared powerfully towards building a strong retirement corpus. Its pension fund manager fees are capped at 0.01%, a small fraction of the 2-2.5% charged by mutual funds.
It used to cap equity investment at 50% of the investment corpus, but this has been raised to 75% in a recent PFRDA decision. This makes the NPS very close to mutual funds in performance and returns.
NPS has a lock-in till the age of 60. You can exit before this age but you will be forced to use 80% of your corpus to buy an annuity (a regular pension) and can only withdraw 20% as a lump sum. In any case, you cannot exit within 3 years of opening the NPS account.
Financial planners will say that you should stick to Systematic Investment Plans (SIPs) and they are not wrong. SIPs have an inbuilt advantage of cost averaging, as we explain here. However many planners ignore the emotions that affect future decisions as the market begins to correct. If you are worried about your future reaction, go for a stronger protection than SIPs. Lock-yourself in.