FundsIndia Views: What should be your time frame and return expectation with equity funds?

March 1, 2017 . Vidya Bala

Most of you, when you started investing with us, would have heard your FundsIndia advisor tell you that equity funds are not meant for the short term. We say this because equity markets and therefore equity funds, are volatile in the short term. That means they can deliver negative returns.

How long can such phases be? What is the time frame over which you need to hold to not lose money and what can be a realistic return expectation? Let’s discuss these points so that you may set your expectations right when it comes to investing in equity funds.

% of times negative returns were delivered
1 year3 years5 years7 years
Large cap funds26.0%7.5%2.5%0.7%
BSE 10026.8%8.4%2.4%0.0%
Diversified funds27.5%7.9%2.8%0.0%
BSE 50028.0%11.8%2.6%0.0%
Mid cap funds25.0%9.0%2.8%0.2%
Nifty Free Float Midcap 10032.0%14.3%1.4%0.0%
Small cap funds26.5%11.2%--
Nifty Free Float Small cap 10041.0%24.5%20.0%5.2%
Balanced Fund21.3%5.2%1.7%0.3%
Crisil Balanced - Aggressive index20.8%0.4%0.0%0.0%
Returns rolled daily for the above time frames over a 10-year period ending February 23, 2017.Fund categories mentioned are FundsIndia-classified categories and the probability of negative returns are averages taken for those categories. 5 and 7-year time frames not considered for small-cap funds due to insufficient data for the period.

Longer time frame insulates you from risk

The table above shows the chances of negative returns had you invested your money and held it for any of the above time frames. For example, there was 1 in 4 chance that you would have ended with negative returns with large-cap funds had you held them for just 1 year (having invested anytime in the past 10 years).

We made some broad inferences on further analysis of the above data:

  • 1-year time frame holds high risk of negative returns across categories. Even in the case of balanced funds, the risk of negative returns, although marginally lower than others, still exists.
  • Almost all categories hold a minimal chance of negative returns post 5 years. In the case of balanced funds, this time frame is just 3 years

Exceptions: Some categories of funds, especially large-cap and balanced funds show a chance of negative returns over a 7-year period even while key indices have a zero probability. How is this possible? This is primarily due to a handful of poor performers. For example, in the large-cap category, the high proportion of negative rolling returns in funds such as JM Core, JM Equity and UTI Top 100 resulted in the 0.7% negative return chance that you see. Median probability of negative returns in the category is zero. This was the case with balanced funds as well.

Therefore, while long-term holding will protect you in most cases, there is no shielding this risk when the funds are bad. If you are stuck with the wrong fund, then your suffering is much more prolonged. This is one reason why consistency in performance and not flashy short-term returns should be the reason for you to invest in a fund.

What to expect?

We discussed that equity funds need a holding period of at least 5-years to avoid negative returns. But the next question is how much to expect from them in the long term. After all, you don’t invest in equity to just preserve capital. You invest to build wealth. Here again, high return expectations, arising from very short-term abnormal rallies in markets, make investors miscalculate what equity funds can deliver. The result? They save less, hoping that high returns will make up for it.

To figure how much you need to save and invest, you need to have a realistic expectation of returns from your funds. The table below will tell you, what proportion of times different categories of funds managed to deliver returns of over 15%. We chose 15% as that seems to be the most popular return expectation among investors.

% of times returns greater than 15%
5 years7 years
Large-cap funds31%43%
Diversified funds37%46%
Mid-cap funds55%26%
Balanced funds39%41%
Returns rolled daily for the above time frames over a 10-year period ending February 23, 2017. Fund categories mentioned are FundsIndia-classified categories. Funds not meeting to minimum instance criteria (because of short track record) were ignored for this purpose.

Here are some inferences from the analysis we made:

  • Large-cap and diversified equity funds deliver superior returns over prolonged time frames. As seen about, there is a 43% chance of this category delivering returns of over 15% over any 7-year time frames in the past 10 years (rolled daily). This is simply because, over longer
  •  periods, they contain down markets (that would have happened during the period) better than midcap funds.
  • Mid-cap funds’ ability to sustain steady periods of high returns is low at 26%. Do not immediately conclude that midcaps are better the short term. For instance, the above data may suggest that it is better to hold mid-cap funds for 5 years than for 7 years. But the 5-year number are an average and it can be deceptive. The average minimum returns that this category has delivered over 5-year periods is 3%! That basically means that in different points in time, the returns can be different. So you cannot be sure you are with the right 5-year bucket!

The way to interpret the mid-cap data would be: it is hard for midcap funds to generate high returns in a sustained manner. Their falls in intermediate bear markets pull down the high returns that they make in bull markets

  • Balanced funds appear steady in terms of their ability to generate sustained high returns

Of course, these averages would be much higher if we remove the few terribly underperforming funds over these periods. Steady performers such as Franklin India Prima Plus in the diversified category and HDFC Balanced in the balanced category, for instance, delivered 15% or more returns three-fourths of the times over any 7-year time frames. That is an astonishing record of consistency.

But if we talk of an average fund, going with a return expectation of 12% (based on past track record; these are not forecasts of the market) seems more realistic for the broad category of equity funds. For example, diversified funds delivered 12% or more returns over 60% of the times over any 5-year time frames. With investing tools like SIP, this average can be much higher.

To sum up, understanding the time frame you need to stay invested in and realistic expectation of returns over such time frame and planning your savings accordingly would help you generate wealth, without much hiccups.

Needless to stay, the choice of funds and staying with consistent performers than flashy performers will ensure you reach your goal on time.

FundsIndia’s Research team has, to the best of its ability, taken into account various factors – both quantitative measures and qualitative assessments, in an unbiased manner, while choosing the fund(s) mentioned above. However, they carry unknown risks and uncertainties linked to broad markets, as well as analysts’ expectations about future events. They should not, therefore, be the sole basis of investment decisions. To know how to read our weekly fund reviews, please click here.

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