Focus on “time in the market” rather than “timing the market”, says research

Unpredictable nature of stock market: Even the most skilled experts struggle to reliably forecast market fluctuations.

Short-term underperformance: Even proficiently managed funds may experience periods of subpar performance over the short term.

Effect of transaction costs: Expenses associated with buying and selling funds can erode your overall returns.

What really matters is “time in the market” rather than “timing the market”. Rather than attempting to predict market timing, it’s wiser to concentrate on long-term investment strategies. This entails investing in a diversified portfolio of funds and retaining them for the long haul, regardless of short-term market fluctuations.

The authors of the research, Kaustubh Belapurkar, CFA and Director and Melvyn Santarita Analyst – Manager Research, Morningstar said, “Over the long haul, the stock market’s outperformance over cash boils down to just a few critical months. Miss those months and you will have missed all the risk premium to be earned from holding a volatile asset such as equities.”

The report emphasizes that Indian stocks’ superior performance over cash from October 2013 to September 2023 can be attributed to only 12 specific months (10 per cent of the months in the sample). This implies that if you held stocks for 108 out of those 120 months, excluding those 12 months, you would not have outperformed cash.

This discovery holds significance as it underscores the value of maintaining a long-term presence in the stock market. Even if you happen to miss some of the market’s most lucrative months, you can still emerge with overall gains in the extended term. Naturally, accurately predicting which months will prove most favourable for the stock market is impossible. Nonetheless, historical data does indicate that certain months have consistently outperformed others.

On average, less than 4.2 per cent of the months are responsible for the entirety of the outperformance observed in Indian actively managed diversified equity funds compared to their benchmarks. This demonstrates that active managers struggle to maintain a consistent edge over the market.

The researchers added, “Active management turns out to follow the same dynamic as the market as a whole. It is thus natural that the implications for buying and selling actively managed funds should be similar to those regarding timing entire markets.”

The previous edition of your study, released in April 2022, revealed that Indian stocks could attribute their entire outperformance over cash to a mere 11 months, comprising only 9.2 per cent of all the months, during a 10-year-period (April 2012 to March 2022). Comparable statistics were observed for actively managed funds, where, on average, a mere six months, constituting just five per cent of all the months, contributed to their outperformance in comparison to their benchmarks.

These findings carry distinct implications for investors:

• Emphasize long-term investing and remain committed during turbulent periods.
• Opt for low-cost, diversified index funds over attempting to time the market or selecting individual stocks and funds.
• Exercise caution with actively managed funds, taking into account their costs and the potential for subpar performance before making investment decisions.

Equities behave similarly everywhere 

The outperformance of equities over cash being limited to some months while staying put otherwise is a global phenomenon. 

In 2019, a worldwide study published by Morningstar unveiled analogous patterns for U.S. large-cap stocks covering investments since 1926, with just five per cent of the months contributing to the overall outperformance compared to cash. Likewise, a global examination of outperformance spanning the last 15 years showed that five per cent of the months were responsible for the outperformance of actively managed funds on a global scale.

Key learnings for investors 

The clear implication of the aforementioned findings is that attempting to time the markets is highly risky. The key strategy is to stay invested, whether it’s in equities as asset classes or the funds you choose for your investments.

• The implication is that investors should refrain from attempting to time their investments in actively managed funds. The key strategy is to remain invested. Actively managed funds are encountering growing challenges in outperforming benchmarks. Furthermore, the duration over which these funds outperform benchmarks is diminishing.
• The best approach for investors is to identify consistently managed funds and maintain their investments. Making investment decisions solely based on recent performance can backfire, potentially causing you to miss out on crucial months of strong performance in both the newly chosen fund(s) and the exited fund(s).

The researchers shared, “Staying invested is the name of the game. Actively managed funds are finding it increasingly harder to beat benchmarks. In addition, the number of months contributing to overall outperformance versus benchmarks of these funds is shrinking.”

“If you think you have identified a skilled manager, the best course of action is to buy in or rupee-cost average, regardless of the moment, and hold on to the fund over long periods. The obvious, and perhaps even the most important corollary, is that a fair amount of patience is required to adhere to such a program,” added the researchers. 

What to expect from your advisor?

A proficient manager may require a considerable amount of time before pivotal months come to fruition. This underscores the significance of maintaining a long-term investment perspective when putting your money into actively managed funds.

Furthermore, it’s crucial to refrain from making decisions solely based on the “what have you done for me lately” mentality. Even the most skilled managers can go through phases of underperformance.

The timeless wisdom that “no one knows the day or the hour when outperformance will strike” holds particular relevance in the realm of active management. This is due to the formidable challenge active managers face in their pursuit to outperform the stock market.

If you’re invested in actively managed funds, it’s essential to exercise patience and allow your managers the opportunity to demonstrate their expertise over time. Avoid making hasty decisions based on short-term performance metrics.

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Updated: 02 Nov 2023, 12:58 PM IST