What Does Rising Valuations Mean for Mutual Fund Investors?

While the market may not be cheap at this level, yet as an investor you should not worry about valuations

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Shishir Nivetia (imaginary name) wants to invest in mutual funds (MFs). But he is hesitant to invest especially since the market is trading at life-time high. At these levels, there are valuation concerns. Everybody, from MF adviser to fund manager, is cautioning about high valuations. Even a common investor suddenly seems to have become value-conscious. There is a feeling that finding a good quality stock in large-cap space is like finding a diamond in the rough. In a situation where even fund managers are fishing for quality stocks, it is common for a layman to get confused when it comes to investments.     


While the market may not be cheap at this level, yet as an investor you should not worry about valuations. In a raging bull market, the fund could have delivered 21% annualized return; the same could mellow down to 16% if you invest at current levels. But it still outpaces returns offered by bank fixed deposits and hence merits an investment.     

Let’s take the case of HDFC Top 100 fund. For someone who invested in 1996 at the NAV of INR 10, the top of the market in 2000 and 2008 would have evoked a similar reaction. The NAV of HDFC Top 100 fund was INR 24 in 2000 and INR 132 in 2008. Same as today, during those periods, too, concerns about high valuations prevailed. Imagine the plight of the investor who did not invest citing high valuations especially when the same fund’s NAV is quoting at INR 462 in 2019. In 2008 markets hit a historic high with BSE Sensex touching 21,000 levels. Today BSE Sensex is trading at the levels of 40,000-plus.

Some advocate assessing valuations based on price-earnings (P/E) ratio of the benchmark. The P/E ratio is the price an investor is willing to pay for a particular stock. The P/E of BSE Sensex was 28 times to its earnings during 2008. P/E ratio alone cannot be used as a yardstick to find value in stocks. Assuming that P/E ratio can be used as an indicator for overvaluation, it cannot be used to assess an MF. An MF holds a diversified portfolio. The P/E of an MF is calculated by averaging the P/E of all the stocks it holds in its portfolio. But a high fund P/E doesn’t indicate that the fund is investing in overvalued stocks or it is too risky to invest. The fund having high P/E may also mean it is pursuing an aggressive growth strategy concerning its investments.

A closer analysis of present bull market reveals that the funds which have pursued growth strategy have been highly successful compared with those who chased value by investing in low P/E stocks. An investor must keep in mind that the fund manager is an expert who is backed by a strong research team, and doesn’t base his investment decisions on P/E alone.

Investment is all about fulfilling life goals. A goal can be to save for retirement or fund for children’s higher education. Goals can be quite intimidating especially if the amount required is huge. The systematic investment through SIPs can help you build a decent corpus besides delivering returns in the long term. The market might test your resolve at different times, but you must continue to invest regardless of market levels.

As an investor, you must guard your investment by tracking it regularly. While there may be some funds which might underperform the market, but you can switch over to the performing funds anytime. Thus, whatever the market condition, your investments will continue to grow and lead to fulfilment.

The important thing is to recognize that MFs are not vehicles of speculation. It is possible to create wealth only if you tone down your expectation from the fund. In the short term, you might not see a significant impact on your investments, but in the long term, you will be surprised by your ability to accumulate the corpus which wasn’t remotely possible if you strive for lump sum.

To sum it up, market levels matter little. The BSE Sensex of 40,000 levels might seem overvalued today. If this is the reason for not investing, then few years hence, the same reason might make you rue when BSE Sensex might trade at 60,000-75,000-plus levels.