Should You Pick Equity Funds That Give 100% Returns in One Year?

Are you looking for an inflation-beating return? Do you seek investments to achieve your financial goals? You may consider investing in equity funds. It may offer inflation-beating returns over time and help you attain your investment objectives. You have many investors seeking 12%-15% returns per annum from equity mutual funds.

However, you have some small-cap funds and sector funds delivering more than 100% returns in just one year. For instance, you have the performance of small-cap funds measured against the Nifty Smallcap 100 TRI. This index delivered a stellar performance of 114% in just one year as of May 03, 2021. Moreover, 17 out of 24 small-cap funds have delivered more than 100% returns in only one year. Should you pick equity funds that give 100% returns in one year?

Should you invest in equity funds based on recent returns?

You have many investors choosing equity funds based solely on one-year returns. The Sensex and the Nifty have surged to record heights from the multi-year lows recorded during the lockdown last year. For instance, the BSE Sensex rose by 92% from March 23, 2020, to March 23, 2021. Moreover, several equity funds, mainly sector funds and small-cap funds, have given high returns due to the economic recovery following the lockdown. 

Many equity funds have performed exceptionally well only because of the surge in the broader markets and not because of the stock-picking skills of the fund manager. You must check the performance of the equity fund over 3-5 years before investing your money. Moreover, you must check essential parameters such as assets under management (AUM), investment style of the fund manager, track record of the AMC, and the equity fund portfolio. 

Many investors believe an equity fund that has given 100% returns in one year will continue to do so in the future. You must not select equity funds based only on past performance, as it doesn’t mean the fund would do well in the future. For instance, many small-cap funds have given returns over 100% in one year and generally perform well during a bull market. However, these funds have also crashed steeply in bear markets, and the past one-year performance does not indicate future performance.

Are small-cap and sector funds suitable for all investors?

Sector funds are equity mutual funds that invest predominantly in stocks of companies belonging to one sector or industry. It is suitable for investors willing to take a high risk for greater returns as the lack of diversification makes it a risky investment. It would help if you timed your entry and exit in sector funds to maximise your returns. 

Small-cap funds are equity funds that invest in stocks of companies with a market capitalisation of less than Rs 5,000 crore. It is suitable for aggressive investors who may time the market to maximise their returns.

First-time investors in the stock market may avoid investing in sector funds and small-cap funds despite the phenomenal returns of over 100% in one year. You have sector funds as concentrated sector-specific investments that are suitable only for market-savvy investors who understand the risks. 

Small-cap funds may perform exceptionally well during a bull market. However, they may crash when economic conditions are unfavourable for smaller companies. Market savvy investors may allocate a small portion of their portfolio towards sector funds and small-cap funds to enhance the overall portfolio performance. 

You may avoid investing in sector funds and small-cap funds through the systematic investment plan or SIP. It is a way of investing in mutual funds where you invest small amounts of money periodically in a mutual fund scheme. You can avoid timing the market if you invest in equity funds through SIP. It helps you stagger your investment across market levels and average out your purchase cost over some time. However, SIPs don’t work for sector funds and small-cap funds as you must time the market to earn maximum returns.

You must invest in equity funds to attain your long term financial goals depending on your risk profile. It will help if you avoid picking equity funds based on one-year returns for primary financial goals. You may consider allocating a small portion of your portfolio towards small-cap funds and sector funds to enhance your portfolio returns if you understand these investments. In a nutshell, first-timers in the stock market may avoid risky mutual funds even if they have given over 100% returns in one year. 

For any clarifications/feedback on the topic, please contact the writer at cleyon.dsouza@cleartax.in