{"id":14078,"date":"2018-07-30T12:54:10","date_gmt":"2018-07-30T07:24:10","guid":{"rendered":"https:\/\/www.fundsindia.com\/blog\/?p=14078"},"modified":"2019-11-08T09:50:07","modified_gmt":"2019-11-08T04:20:07","slug":"effect-of-stock-market-volatility-on-fund-returns","status":"publish","type":"post","link":"https:\/\/www.fundsindia.com\/blog\/mf-research\/mutual-funds\/effect-of-stock-market-volatility-on-fund-returns\/14078","title":{"rendered":"FundsIndia Explains: Effect of volatility on fund returns"},"content":{"rendered":"

Over the last 6 months, markets have been in the red often. While BSE Sensex and NSE Nifty 50 are back to their all time highs, small and midcap indices are far from their January 2018 peaks. The BSE small cap index has fallen by 19% and Mid cap index is down 12% from their Mid-January levels.<\/span><\/p>\n

This is the time when investors start to panic. They wonder if they should get out of their funds or stop their SIPs<\/a>. In the past, we have addressed why <\/span>continuing to invest during the downturn<\/span><\/a> is essential to make good gains from equity. <\/span><\/p>\n

However, this article is not about that. This article tries to address the basic concern of why investors panic and whether there is a reason to panic. And finally, it tries to answer what measures an investor should take to prevent future shocks.<\/span><\/p>\n

Understanding volatility<\/span><\/h3>\n

To explain this, it is important to first explain volatility. Volatility is a measure of variation in the price of an asset. This variation is measured by taking the average difference between the highest and lowest prices of the stock over a period of time. A stock which rises more, falls more.\u00a0<\/span><\/p>\n

Often times, volatility is used as a synonym for risk. This is ok for textbooks but is not really the case. Volatility is either a reaction to a risk event or an anticipation of a risk event that may or may not transpire. Volatility, therefore, tends to be higher in asset classes where prices are driven mostly by sentiments or where there isn’t enough information or direction or fundamentals about where the asset class or the company is headed. Bitcoins are a classic example of a high-volatile asset class not backed by sufficient fundamentals. Similarly, in the equity space, small-cap stocks are more prone to volatility simply because the likelihood of risky events transpiring is higher than in a large-cap stocks.\u00a0 The information arbitrage is also higher in small-cap stocks than in large-cap<\/a> stocks. Thus, volatility causes sharp swings in the performance of an instrument\/asset class.\u00a0<\/span><\/p>\n

Effects of volatility on the market<\/span><\/h3>\n

Consider this – during the years 2007 to 2017, there were 263 instances where BSE Small cap index fell by 10% within a month and 31 instances when it fell by 10% within a week. Imagine investing Rs. 5,00,000 in a fund and seeing its value fall to Rs 4,40,000 in a week. How would you react? In contrast, the number of such instances in the BSE 100 index were just 134 and 19 over a month and week respectively.<\/span><\/p>\n

However, the year 2008 was an anomalous year. We generally don\u2019t see such catastrophic falls. So we also counted the number of times these indices fell by more than 10% in a month after leaving out this year. The numbers were 148 for small cap index and 43 for BSE 100. So even if you had escaped the major correction, your small cap portfolio would have suffered many more times than your large cap portfolio.<\/span><\/p>\n\"10_percent_fall_during_2007_to_2017_volatility_in_smallcap\"\n

This does not however, mean that small caps give poorer returns. Over the last 5 years, BSE Small cap index has given annualised returns of close to 25%. This despite having experienced a 10% monthly fall on 27 occasions. In the same time, BSE 100 index has given returns of 15.4% per year, having experienced monthly falls of 10% or more on six occasions. And this demonstrates how volatility can be your friend if you are willing to take the pain.<\/span><\/p>\n\"10_percent_fall_during_last_five_years\"<\/a>\n

So what does volatility do to you? It gives an impression that you have lost money by investing. The fact that it is a temporary fall and will bounce back does not seem logical in a state of panic. Hence, volatility triggers action on your side. And the action is often detrimental to your investments. How can you keep this action under check? Read on. <\/span><\/p>\n

Learn how to manage volatility<\/span><\/h3>\n

Volatility is a given but there are some simple tools to manage volatility. <\/span><\/p>\n