The markets have bounced back sharply from the sharp correction in March last year after the Covid-19 outbreak. Strong FPI flows and hopes of further reforms in the upcoming budget have been driving the market to fresh all-time highs. Amidst this market uptrend, the mutual fund industry has been witnessing steady outflows from equity funds. This reflects on the investors’ perception of booking profits regularly during times of high market valuations.

However, the exceptional circumstances created by the pandemic have also led to exceptional responses from the governments of several developed economies. Countries across the globe have loosened their purse strings with liberal stimulus policies.

The economic revival based on government stimulus and increased levels of industrial activity can potentially fuel the next rally in the equity markets. Except for a couple of sectors, the remaining sectors have rebounded reasonably well. The pent-up demand during the lockdown period is also unwinding steadily in the consumption and hospitality sectors.

Robust inflows

Retail investors have continued to reflect mature investment behaviour as SIP inflows have remained robust and consistent. Even during the turbulent times of the Covid-19 outbreak, the monthly SIP inflows have sustained above Rs 7,300 crore. The SIP inflows stood at Rs 8,418 crore in December 2020, the highest monthly inflow in the current financial year.

While the valuations seem to be expensive according to the historical valuation multiples, the same will have to be evaluated in the context of sustained economic revival and lower cost of funds for the corporates. This in turn can help market re-rating leading to multiple expansion. However, one cannot expect investment performance across different pockets to be the same.

The recent outperformance has been polarised within a select few stocks and sectors, while the broader equity markets have not performed well. Thus, while the valuation in some narrow segments appears to be rich, a good part of the broader market still looks reasonable.

The right market segment

Amidst the wide spectrum of market emotions, it is a million-dollar question for the investors to choose the right market segment. This becomes more complex for the investors as the markets have been diverse regarding the segments that have outperformed during the last decade.

In the last decade — from 2010 to 2019 — large-cap and mid-cap segments have been winners four times each, while the small-cap segment was the winner only twice. So, while large-cap funds were the winners in four years, they were also the underperformers for another five years.

As such, predicting market winners remains a challenge for investors. Instead, investing across market caps may help generate potentially better returns over the long run as investors can seize attractive investment opportunities across segments.

The broader markets also tend to outperform in the uptrend phases and the current phase seems similar to previous market rallies in 2003-2007, 2008-2010, 2013-2015 and 2016-2017. This is where multi-cap and flexi-cap funds emerge as the saviour for the investors as these funds enjoy the flexibility of investing in different market capitalisation segments.

The flexibility embedded within multi-cap funds has also helped such funds to remain popular among investors. Such funds are the second-most popular among open-ended equity funds with AUM (assets under management) of Rs 1.68 lakh crore as on 31 December 31, 2020, with a 19 per cent share (Source: Association of Mutual Funds in India).

Collective wisdom

The investors can further mitigate the risk of investing in the equity markets by investing through passively managed funds. There are also fund of funds which invest across large-cap, mid-cap, and small-cap funds/ETFs, providing investors with the flavour of of multi-caps/flexi caps.

Such funds are not reliant on the wisdom of one or two fund managers but instead aim to gain from the collective wisdom of the equity markets.

As selecting winners has been tougher, the market consensus can often guide towards the right investment allocation across different market segments. The returns are further optimised for investors because of the lower expense ratios of such passively managed funds.

Such diversified exposure also helps the funds compensate for the underperformance of select stocks, thereby providing a sense of stability in the portfolio returns. These funds can be considered suitable for investors with a moderate to aggressive risk profile.

Further, the rebalacing of investment allocation among different segments does not trigger any tax-related compliances unless the investor himself redeems his/her investments. As such, the investors can also benefit from the tax-efficiency of mutual funds as the gains are taxable for the investors only at the time of realisation.

Betting on the possibilities of an economic revival, equities continue to offer interesting opportunities. The investors can consider investing in multi-cap/ flexi-cap funds with investment exposure across market capitalisation segments to gain from the collective market wisdom. This also sets aside investor dilemma of choosing specific market segments to invest in.

The writer is co-chief business officer, Nippon India Mutual Fund