Strategy when markets fall


Equity diversified funds invest in stocks, which are expected to offer superior returns. The performance of such funds depends on the fund manager’s investment skills.

During the week ended 26 May 2006, while the Sensex fell by 1.18 percent, average performance of this category of equity funds was a negative 1.52 percent. Funds that have been consistent performers in the last on year period offered mixed results. While 2 top offered negative returns of 1.79 percent and 4.15 percent respectively, 2 other top-per forming funds offered much lower negative returns at 0.25 percent and 0.52 percent respectively.

Equity diversified funds in India have out performed the stock market indices consistently. However, when there is an across the-board market meltdown, these funds are bound to get affected during the meltdown period. Investing in these funds cannot be a short-term exercise. One need to stay invested over a period of 2-3 years in order to make profits.

An index fund tracks a particular stock market index. This results in its performance being similar to the movement of the index. The performance of an index fund may be better or worse than the index tracked. However, during this fall, most index funds returned a much a much lower negative performance than the Sensex and the Nifty . For instance, the Canindex Fund and SBI magnum Index Fund, both of which track the Nifty, gave negative returns of 0.28 percent and 0.53 percent respectively against the Nifty, which fell by 1.15 percent during this period.

The reasons for deviation in performance of an index fund vis-à-vis the index being tracked are many. Three main reasons are:

1. Although the index fund invests in the stocks forming the particular index tracked, the percentage of holding of the stock will be different from weightage of the stock in the index. For instance, in the case of the Canindex Fund ONGC forms11.1 percent of the corpus of the fund, while the weightage of ONGC in the Nifty is 11.21 percent.

2. When an index being tracked undergoes a change (a stock is replaced) , the index fund tracking that index may not make the change in its portfolio right away i.e. sell the stock, which has been removed from the index tracked and buy the stock which has been included in the index tracked.

3. The mutual fund levies management and administration fees on the index fund. These costs affect the fund’s performance.

Investing in an index fund ensures that your losses do not significantly exceed the fall in the index (this can happen in diversified equity funds).

Sector funds are mutual fund schemes that invest in stocks and securities forming a particular industry. For instance, pharma funds invest in stocks of pharma companies, banking funds invest in stocks of banks, etc. In this market meltdown, some sector funds actually offered positive returns. For instance, in the market crash week ended 26 May 2006, the SBI Magnum FMCG Fund returned a positive 1.6 percent, the Reliance Media and Entertainment Fund gave a positive return of 0.88 percent ad the JM Healthcare Fund returned a positive 0.25 percent. The other sector funds gave negative returns but the amount of fall was not in sync with the Sensex or Nifty.

Focusing on a particular sector is riskier since there is no diversification of your investments. However, falls such as the recent one are not sector-specific. It makes sense to invest in a fund focusing on a sector or sectors you are familiar with.

We conclude by advising in a situation of market crash, if you are an investor, it is preferable to simply do nothing. If you have liquid cash, then you get an attractive buying opportunity. The biggest mistake to make is to sell impulsively. Investing is a long term game. The stock markets have been in existence for decades and have successfully survived different kinds of crisis. Panicking in times such s these is the biggest mistake you can make.