Market volatility and its impact on equity mutual funds

In the dynamic world of finance, where opportunities and uncertainties are interconnected, market volatility is a prominent factor that influences investment outcomes. For individuals in pursuit of wealth generation, understanding the relation between market fluctuations and equity mutual funds is paramount.

In this article, we will take you through the impact of market volatility on equity mutual funds. We will also discuss the details, tactics, and a few tips that can help investors withstand the ever-shifting trends of the financial markets.

• Table of contents

1. What is volatility in mutual funds?
2. Market volatility and mutual funds
3. Equity funds in a volatile market
4. Strategies for withstanding volatility
5. Factors causing market volatility
6. How do mutual funds get affected due to market volatility?
7. Benefits of mutual funds in market volatility

What is volatility in mutual funds?

Volatility, within the context of mutual funds, indicates the magnitude and frequency of price oscillations in the underlying assets. It serves as a quantitative measure of the degree to which the value of assets experiences fluctuations over a specific period.

While volatility might evoke feelings of fear, it is imperative to recognise that it is an intrinsic facet of any market ecosystem and extends beyond the confines of mutual funds.

Therefore, rather than being a cause for alarm, volatility represents the market's inherent unpredictability and embodies the rapidity with which prices can surge or fall.

Market volatility and mutual funds

The relationship between market volatility and equity mutual funds shapes the trajectory of an investment’s performance. Equity mutual funds comprise the stocks of diverse companies and their returns depend on the performance of these stocks. In periods marked by increased market volatility, the intrinsic value of individual stocks undergoes frequent oscillations, thus affecting the overall value of the mutual fund.

However, in the midst of heightened volatility, the human element often comes into play. Investors, driven by the emotional currents of fear and uncertainty, might be inclined to undertake impulsive actions, such as panic selling of their mutual fund holdings.

Yet, it is imperative to recognise that such hasty responses might not necessarily align with the principles of astute long-term wealth generation.

Equity funds in a volatile market

Equity mutual funds are inherently more susceptible to market volatility due to their substantial exposure to stocks. While this heightened exposure amplifies equity funds’ potential for relatively reasonable returns, it simultaneously ushers in an elevated degree of risk.

When the market is volatile the valuation of the underlying stocks undergoes oscillations, leading to equivalent fluctuations in the net asset value (NAV) of the equity mutual fund.

For equity fund investors, a strategic mindset is an indispensable asset in the face of market volatility. Rather than succumbing to the currents of fear, an investor's decision to remain steadfast and invested despite the declines and flows of the market can yield to good outcomes over an extended time horizon.

Moreover, history bears testament to the resilience of the markets, showcasing their capacity to rebound from downturns and ultimately rewarding those who champion a stance of patient resolve.

Strategies for withstanding volatility

Diversification: A judicious strategy to mitigate market volatility revolves around diversification. Equity mutual funds that meticulously distribute investments across an array of industries and sectors tend to be less influenced by the suboptimal performance of an individual stock or sector. This strategic dispersion acts as a buffer, minimising the impact of adverse market movements.

Systematic investment plans (SIPs): SIPs inculcate a disciplined approach to investments, permitting individuals to allocate a fixed sum at regular intervals. This calculated method facilitates the gradual averaging out of the investment cost and minimises the impact of market volatility. In essence, during market troughs, the investor procures more units, and conversely, during market peaks, fewer units are acquired. You can use a SIP interest calculator to understand the potential returns.

Long-term focus : Adhering to a long-term perspective is a tried and tested way of making the most of equity funds in volatile markets. Transient market fluctuations should not have undue influence over investment decisions, especially when the overarching goal is wealth generation. Investors should always remember that equity mutual funds are designed to foster sustained growth over an extended span of time.

Factors causing market volatility

Market fluctuations refer to changes in asset prices, including stocks, bonds, and mutual fund units. These are typically driven by changes in investor sentiment based on news and Various factors contribute to these movements in the Indian market. Below are some key drivers of market fluctuations:

• Global economic developments: Economic shifts worldwide, such as central bank interest rate adjustments, trade disputes, or geopolitical events, can influence investor sentiment and lead to fluctuations in the Indian market. For instance, a slowdown in global economic growth may reduce foreign investments in India, affecting market trends.
• Domestic economic indicators: Market sentiment can be shaped by economic data such as inflation rates, GDP growth, and employment figures. Unexpected weak data can trigger selling pressure, while favorable data can boost confidence. For example, a sudden rise in inflation may lead the Reserve Bank of India (RBI) to increase interest rates, raising borrowing costs for companies and affecting stock valuations.
• RBI policy decisions: The RBI’s monetary policies, including adjustments to repo rates, reverse repo rates, and cash reserve ratios, influence liquidity and investor confidence. These policy changes can drive market movements. For instance, a repo rate cut can enhance liquidity, potentially encouraging investments and supporting stock prices.
• Corporate earnings and business developments: Company-specific factors, including earnings reports, mergers, and leadership changes, can impact stock prices. Strong earnings may boost investor confidence, while weaker-than-expected results can lead to declines.
• Political and regulatory shifts: Uncertainty arising from political events, policy modifications, or regulatory changes can affect investor confidence. For instance, unexpected government decisions impacting specific industries may lead to market fluctuations.
• Foreign Institutional Investor (FII) activity: The movement of foreign investment plays a major role in market performance. Large-scale withdrawals by FIIs can put downward pressure on stock prices, whereas substantial inflows may support the market.

How do mutual funds get affected due to market volatility?

Below is an overview of how mutual funds are typically influenced by market fluctuations:

Equity funds: Equity funds, which primarily invest in stocks, can be significantly impacted by market movements. A market decline can lead to a drop in the Net Asset Value (NAV) of equity funds, while an upswing can result in potential gains. This is one of the reasons why equity funds entail high risk, especially in the short term.

Debt funds: Debt funds, which invest in fixed-income securities like bonds and government instruments, tend to be relatively less volatile than equity funds. However, they are not completely insulated from market shifts. Interest rate changes can affect bond prices, influencing the NAV of debt funds. Among other factors, rising interest rates owing to inflation or monetary policy decisions can lower bond prices, reducing NAV. While they generally carry lower risk than equity funds, debt funds are still subject to some fluctuations.

Hybrid funds: The extent of the impact on hybrid funds depends on their asset class mix. Funds with greater equity exposure will be more volatile than those with a higher debt allocation.

Effect on sectoral funds: Funds that focus on specific industries or sectors can be particularly responsive to market fluctuations as they are affected by general as well as sector-specific market trends. Developments impacting a specific sector can lead to notable price swings in the stocks of companies within that sector, affecting the NAV of these funds.

Benefits of mutual funds in market volatility

Market fluctuations, although often seen as a risk, can offer several advantages for investors who actively manage their mutual fund portfolios. Below are some key benefits:

Opportunity to buy at lower prices: During market downturns, the Net Asset Value (NAV) of mutual fund units, especially equity funds, may decrease, presenting an opportunity to acquire more units at a lower price. This could lead to higher returns when the market recovers, essentially allowing you to buy assets at a discount.

Rupee cost averaging with SIPs: Systematic Investment Plans (SIPs) offer a strategic advantage in volatile markets. By investing a fixed amount regularly, you purchase more units when prices are lower and fewer when prices rise. This strategy helps average out your purchase price over time, reducing the impact of market swings.

Potential for long-term growth: Although market fluctuations may be unsettling in the short term, markets have historically* bounced back from downturns. By staying invested and managing your portfolio effectively, you can potentially benefit from recoveries and position yourself for long-term growth.

*Past performance may or may not be sustainable in the future.

Conclusion

When aiming to create wealth using mutual funds over time, there is no getting away from the ups and downs of the market. Understanding the link between market changes and the impact of market volatility on equity mutual funds is essential for making smart investment decisions. While market instability might create uncertainty, it also provides opportunities for those who use strong and steady investment approaches. However, as you start your journey to build wealth, it's crucial to take advice from financial experts. They can provide tailored insights based on your financial goals and risk tolerance. By combining careful thinking with practical steps, you can potentially withstand unpredictable market shifts and work towards your goal of creating wealth over long term.

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FAQs:

How does market volatility affect equity mutual funds?

Volatility can lead to fluctuating fund NAVs, impacting short-term returns but often lessening its effect on long-term investments.

Are there strategies to navigate volatile markets?

Diversification, SIPs, and maintaining a long-term perspective can help investors mitigate the impact of market fluctuations.

What's the role of fund managers during market volatility?

Skilled fund managers adjust portfolios to align with market conditions and aim to mitigate impact on capital invested.

What should investors avoid during periods of market volatility?

Avoid making impulsive decisions driven by fear or panic selling. Don't try to time the market, as that is difficult and risky. Refrain from making significant portfolio changes based on short-term market fluctuations. Stick to your long-term investment plan and do thorough research before making investment decisions. Consulting a financial advisor is recommended.

Why is diversification important during market volatility?

Diversification across different asset classes can help mitigate losses during volatility. This is because different asset classes tend to respond differently to market conditions. When some asset classes decline, others may remain relatively stable or even increase in value, providing a buffer to your portfolio. It reduces overall portfolio risk.

How can systematic investment plans (SIPs) help during volatile markets?

SIPs can leverage volatility through rupee-cost averaging. By investing regularly, you buy more units when prices are low and fewer units when prices are high, averaging out your purchase cost over time. This can help you potentially optimise long-term return potential and capitalise on market dips.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.