Why investors are becoming disillusioned with equity mutual funds

Following years of robust equity mutual fund inflows, evidence of investor disillusionment is now starting to emerge. As SIPs continue to draw consistent contributions, retail investors are increasingly getting nervous about equity fund performance in the wake of changing market dynamics and increasing interest rates. The trend is a harbinger of a combination of reasons that are leading investors to rethink their exposure to equities—and to challenge mutual funds as the optimal tool for securing long-term financial objectives.

Volatility is eroding investor confidence

The recent stock market volatility has been a driving force behind cooling investor interest. Following a steep post-pandemic rebound in 2021 and 2022, global equity markets have become much more volatile. Ongoing geopolitical uncertainty, increasing interest rates among big economies, and fears of easing growth have dampened sentiment.

Most retail investors who invested in equity mutual funds during the bull phase invested in anticipation of double-digit returns. With increases in market volatility and returns lessening, this disconnect between expectation and reality has resulted in disappointment and hasty exits. More and more investors are now wondering if they can count on equity funds to create stable wealth.

Active fund underperformance is driving disappointment

Yet another reason for the sentiment shift is the poor performance of a large number of actively managed equity mutual funds, especially in the large-cap segment. Over the last few years, many active funds have not been able to consistently beat benchmark indices like the Nifty 50 or Sensex. However, index funds and exchange-traded funds (ETFs), which have significantly lower expense ratios, are providing competitive returns.

This has brought many investors to wonder whether they should pay a premium for management fees to invest in active funds if passive ones can catch up or surpass them. Increasing cost-to-return visibility is making retail investors more picky about where they invest.

A short-term mentality is damaging long-term returns

Investor habits are also contributing towards the discontent. Most retail investors have a short-term approach towards equity mutual funds, often influenced by market action or social media frenzy. They like to take quick profits in up markets or redeem units in a hurry during corrections. This kind of habitual response denies them the full advantage of long-term compounding.

When short-term exits translate into below-average returns, it only lends credence to the notion that equity funds are risky or unpredictable. Experts warn that unless investors adhere to a disciplined, long-term investment frame of mind, they will not be able to tap the full potential of equities.

Increased popularity of safer options

Concurrently, fixed income products are gaining traction. With public sector banks and small finance banks providing nearly 8% fixed deposit rates, conservative investors and retirees alike

are reallocating money away from equities in favour of guaranteed returns. Correspondingly, gold ETFs, hybrid funds and other alternative products are gaining traction too.

With rates set to stay high in the short run, the attractiveness of secure, certain returns is siphoning funds out of plain equity plans. For most investors, the security of capital protection is trumping the promise of greater—but less predictable—returns from equities.

Transparency and charges are issues

Increased recognition of fund management charges and portfolio turnover expenses is another reason for investor wariness. While the mutual fund sector has enhanced transparency, however, some consumers are still unsure about what they are getting and whether or not fund managers are providing adequate value for money.

As fund performance underperforms and costs are evident, discontent arises naturally. Investors are more sophisticated and demanding, demanding performance as well as transparency from their fund managers.

A mix of unstable markets, actively managed fund underperformance, short-term investor sentiment and the increasing popularity of fixed-income substitutes is propelling rising disillusionment with equity mutual funds. Still, fiscal experts keep arguing that equity funds are still an effective instrument for long-term wealth building—so long as investors use them with realistic expectations and a long-term attitude.

In today’s environment, investing for one’s own goals and risk tolerance is more crucial than ever. For the disciplined investor, equity mutual funds continue to hold great promise. But the secret is knowing the risks as well as the potential rewards—and selecting funds and approaches that best fit one’s long-term financial goals.