Mutual funds: How market price correction would affect the value of your large-cap, mid-cap, small-cap funds. Check details
Mutual fund investment: Since reaching the peak of 85,000 in September, the BSE dropped to 77,500 on Monday, falling steadily over multiple trading sessions. However, on Tuesday, bulls regained control in today’s trade as benchmark indices Sensex and Nifty rebounded after several days of downtrend, driven by value-buying at lower levels.
In the past one month, all equity mutual fund categories have offered negative average returns in the last one month. These categories lost between 0.82% to 12.42% in the mentioned period. There were 22 equity mutual fund categories including sectoral and thematic funds in the said period.
A recent analysis by Ventura Securities sheds light on a critical aspect of this challenge: drawdowns and the performance of mutual funds during market downturns. Here are the key highlights:
1. Market drawdowns
In investment analysis, a drawdown serves as a crucial indicator that evaluates the gap between the peak value of an asset and its lowest point following a decline. Fundamentally, it signifies the extent of loss incurred by an investment before it initiates its rebound and the duration required to reach its previous high point. Drawdowns are comprised of two primary elements: price adjustments reflecting the decrease in value, and time adjustments representing the period needed for the investment to recover.
2. Price Correction
Price corrections occur when the value of a mutual fund or stock decreases from its highest point. These drops can be concerning, but they are typically temporary for mutual funds, unlike individual stocks. For example, during the COVID-19 pandemic, the Indian equity market saw significant declines.
3. Mutual fund drawdowns
Ventura’s report focuses on mutual funds that had notable drawdowns between January and March 2020, particularly in large-cap, mid-cap, and small-cap categories.
a. Large Cap: Nippon India Large Cap saw a 32.3% drop
b. Mid Cap: ICICI Pru Midcap dropped by 32.0%
c. Small Cap: Aditya Birla SL Small Cap fell by 34.3%
However, there were some funds that experienced less severe decreases:
Large Cap: JM Large Cap Fund observed a decrease of 11.9%
Mid Cap: Axis Midcap saw a drop of 18.0%
Small Cap: Bank of India Small Cap fell by 16.1%
The variations in drawdown percentages demonstrate the diverse levels of market volatility and the resilience of various mutual fund categories.
4. Recovery time
The report highlighted that although market corrections can be unsettling, mutual funds typically bounce back over time. A recent analysis by Ventura explores the recovery period, or the duration it takes for funds to return to their previous peak values.
The findings reveal that funds with smaller declines tend to recover more quickly:
Large Cap: JM Large Cap Fund recovered in 4 months
Mid Cap: Axis Midcap saw a rebound in 4 months
Small Cap: Bank of India Small Cap recovered in 3 months
Conversely, funds that experienced more significant declines took longer to recover:
Large Cap: Nippon India Large Cap took 9 months
Mid Cap: ICICI Pru Midcap recovered in 6 months
Small Cap: Aditya Birla SL Small Cap bounced back in 7 months
These observations emphasize the varying resilience of mutual funds and emphasize the importance of maintaining investments during market corrections, especially when the recovery follows a predictable trend.
Investment strategy
The report noted that one key benefit of investing in a mutual fund is that it always has a steady stream of funds coming in from new investors, allowing them to take advantage of buying opportunities in the market when prices are low. Additionally, mutual funds do not incur impact costs, as they are pass-through vehicles and are not subject to capital gains tax like direct stocks. This means that mutual funds do not have to pay taxes on their buying and selling activities.
Another advantage of mutual funds is that they do not face permanent drawdowns. While they may experience temporary losses, they typically recover over time.
In contrast, investing in individual stocks carries the risk of permanent drawdowns, where the value of the stock may never fully recover. Examples of this can be seen in companies like Kingfisher Airlines and Jet Airways, the report highlighted.
“We have seen that both price and time corrections play a crucial role in market cycles. All you have to do is remain patient. Although market corrections can be unsettling, history shows that markets do tend to recover over time,” noted the study.