On Nov 8, 2016, the Indian government declared that all the 500 and 1000 rs notes will cease to be legal tender from the next day. The bold step, meant to remove the fake currency and clean up the black money, had many expected and unexpected effects on the overall economy. These economical developments can be observed to predict the impact of demonetization on mutual funds in India.
What is expected to happen as a result –
The impact of demonetization on the overall economy is well summarized here. At a sector level, the demonetization impact is expected to be
Let’s see how demonetization is likely to impact the growth of the various categories of Mutual Funds.
Portfolio – invests in a diversified basket of equity stocks of companies whose market capitalization is at least equal to or more than the least market capitalized stock of BSE 100 Index.
Expected impact: Slightly Negative in short term, but positive in long term
Since the growth rate is expected to come down for next 1-2 years, this would reflect in the overall performance of Large Cap stocks. In long term, the demonetization impact on India growth story is very positive.
Top mutual fund in this category-
The top composition of the fund is in Financial (23%), Auto (11%), Healthcare (10%) and Energy (9%). This fund has given ~ 20% whereas S&P BSE 100 has given ~10%.
Portfolio- The fund invests 50-90 percent in large-cap stocks, 10-40 per cent in mid-cap stocks and up to 10 percent in small-cap stocks
Expected impact: Slightly Negative in short term, positive in long term
Multicap funds are expected to be very volatile in short term. People are going to be uncertain of what is the expected growth and therefore they will react to every event – budget, GST, interest rate change etc.
In long-term, it is expected to give good returns. People will start preferring equity investment (mutual funds or direct) more than other traditional – real estate, gold etc.
Top mutual fund in this category-
The fund has generated ~ 39% return in past 3 years.
Top 3 sector holding of this scheme are Financial (~30%), energy (~12%) and automobile (~11%)
Portfolio – fund invests in equity of the companies which are not part of the top 100 stocks by market capitalization and market capitalization of at least Rs.100 Crores
Expected impact: Negative in short term and positive in long term
These are most volatile mutual funds. In short term, due to the uncertainty and lack of disposable cash, they are expected to perform badly. But in long term, a well managed small cap fund can outperform a large cap or multi-cap by aptly selecting the sectors.
Top mutual fund in this category
Mirae Asset Emerging Bluechip Fund
Relatively new and small fund (launched in 2010, 3K Cr AUM), it has outperformed other funds in this category in the past 3-5 years. The fund has generated around 41% return in past 3 years. The top composition of the fund is in Financial (21%), Services(10%), Energy (10%) and Chemicals (8%)
Portfolio- invests in a range of debt instruments and money market instruments to maintain the optimum balance of yield, safety, and liquidity.
Expected impact: Positive in short term and less positive in long term
Banks will get expected to receive 8-9 lac crore as surplus deposits. Even with a decline in loan rates, this amount of money is not going to get dispersed in next 1-2 years. As a result, every bank would buy bonds. This would result in high returns for the long term debt funds for a short term (~1 year). But in the long term, since the interest rates are expected to go down, the debt fund returns will go down too.
Top mutual fund in this category-
ICICI Prudential Long Term Plan
With the safety of debt funds, this fund has given 13-14% returns in last 3 years. In the past 20 days, the fund has given more than 20% annualized returns. Average maturity is ~9.3 years whereas Yield to maturity is ~7.4%. Composition consists of ~ 57% is SOV and ~37% AAA.
Portfolio -invests in debt and money market instruments with relatively low levels of interest rate risk
Expected impact: Positive in short term and less positive in long term
Similar to long term debt, short term debt (or liquid funds) are expected to give good returns in short term. Primarily because of the high demand for these instruments, from both banks and retailers. Banks are buying bonds to park excess inflows, whereas retailers are buying because they find short-term debt as the best options to park their money till the demonetization dust settles down and they have better investment avenues. In long term, however, the short-term debts are expected to give slightly lesser returns than today. Short term debt funds have given 8-10% returns in last 1-2 years. Once the interest rates are reduced, the expected returns on these funds would come to 7-9%.
Top mutual fund in this category-
Birla Sun Life Treasury Optimizer Plan
This fund has performed consistently in past 3-5 years giving 10-12 % annualized. Average maturity is ~5 years whereas Yield to maturity is ~7.6%. Composition consists of ~ 40% is SOV and ~30% AAA.
Overall, the demonetization impact on mutual funds growth is expected to stay for 1-2 years. Beyond that, it’s expected to the transition of unorganized to organized among various sectors. Therefore, long-term investment decisions are not advised to be biased by such events. In short term, you can refer to the above discussion while choosing funds for investing.