Explained: What’s driving the fresh optimism around MFs

Investors pumped Rs 10,082 crore into equity and equity-oriented schemes amid the 3,200-point rise in the Sensex during May.

In May, even as the country was facing its biggest health crisis, the mutual fund industry witnessed the highest net inflow since March 2020. While some say the markets are delinked from the realities of the economy, insiders say it is a reflection of optimism about what lies ahead.

Why did equity assets under management rise so much despite the Covid surge?

Investors pumped Rs 10,082 crore into equity and equity-oriented schemes amid the 3,200-point rise in the Sensex during May. The buoyant markets have given good returns to mutual fund investors in the last three months. A decline in new Covid cases and the possibility of economic recovery picking up boosted morale despite the sell-off by foreign portfolio inveistors.

“Broadly, we understand from the first wave of Covid that these waves will be short-lived and eventually economic activities will revive, giving a boost to the market sentiment. Therefore, buying on dips always makes sense, which is what is reflecting in the mutual fund sales numbers quite positively,” said Akhil Chaturvedi, Head of Sales & Distribution, Motilal Oswal Asset Management Company.

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Another theory is that lower spending prompted investors to divert money into mutual funds. Investors have put over Rs 25,000 crore in equity schemes in the last three months, taking the total investments in equity schemes to Rs 10.67 lakh crore and another Rs 3.71 lakh crore in hybrid schemes as on May 31. “Investors who have accumulated higher savings in the last year due to lower spending and were staying on the sidelines are slowly coming back. The strong returns in equities and the stability of the markets despite the second wave provide the much-needed positive nudge,” said Arun Kumar, Head of Research, FundsIndia.

Have redemptions from equities slowed?

Equity MFs witnessed redemptions amounting to Rs 36,220 crore in December 2020, and Rs 33,383 crore in January 2021. The average monthly redemption between July and February was Rs 24,406 crore, but came down to Rs 15,550 crore in May, the lowest since July 2020.

After eight months of net outflows (aggregate Rs 46,788 crore), the industry has witnessed net inflows of Rs 22,634 crore in the last three months. And after averaging Rs 18,557 crore between July and February, gross sales have risen to an average of Rs 25,244 crore in the last three months.

Industry insiders say the continued strength in markets over the last three months and optimism around vaccination and continuing economic activity have led to people slowing down on redemptions.

What are the factors driving investor optimism and holding the markets?

While the Covid spike caused a scare between April and May, economic activity did not get fully derailed as the Centre desisted from announcing a nationwide lockdown. Many feel the June quarter numbers may not be as bad as they were last year.

If strong earnings for the March quarter kept investor sentiments high, fresh investments continued in May on the optimism that the economy will be back on the growth path after the second wave is brought under control and vaccination picks up, especially after the Prime Minister’s announcement that the Centre will procure 75% of doses and give them free to state governments.

A top official with a mutual fund said economic activity is back and there is a rise in power consumption, railway freight, vehicle registration, e-way bill generation and other parameters. Not only domestic investors but even foreign investors have come back. NSDL data shows that while FPI in equities in April and May witnessed a net outflow of Rs 9,659 crore and Rs 2,954 crore respectively, in June (till date) FPIs have invested a net of Rs 14,078 crore.

Nilesh Shah, MD, Kotak Mahindra AMC said that while hopes of a stronger recovery and improving economic indicators are giving confidence to investors, they are also coming back to MFs after having seen that in times of need, the money in MFs was always available. “There have been numerous examples over the last 8-10 months when people withdrew money from MFs when they needed it to run their livelihood or meet other family needs. The role played by MFs as an investment instrument over the last one year, has only reemphasised its importance within a family, and we are seeing not only the existing investors coming back with more investments but also getting their family and friends to do that,” Shah said.

What are the risks?

The biggest risk factors are the pandemic, the possibility of a third wave, and lockdowns. The RBI’s monetary policy panel pared India’s GDP growth forecast for the current financial year by 100 basis points to 9.5% because of uncertainties created by the second wave. When the RBI and other central banks unwind the accommodative monetary policy once the situation normalises, there could be pressure on liquidity and sell-off by foreign investors. Inflation is another worry. “We had flagged inflation as an emerging threat for economic recovery and equity markets. Energy and food prices remain a concern,” said Sorbh Gupta, Fund Manager -Equity, Quantum Mutual Fund.

On the other hand, the RBI has raised the red flag over a possible bubble in the stock markets that had surged to record highs after the pandemic hit. It had raised the same concern last year too, when stock prices skyrocketed.

Prices of risky assets across countries hit record highs during 2021 on the back of unparalleled levels of monetary and fiscal stimulus. Whether this buoyancy in markets will sustain will depend on the economic recovery.

According to an analyst, the red flags are on valuations, particularly in mid- and small-caps. Past experience suggests that when mid-small cap valuations rise beyond large-cap valuations, which is the case now, there can be sharp corrections. Investors have to exercise caution and go for high quality stocks only, he said.

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