In a year marred with a war in Europe and Central Banks around the world rushing to raise interest rates to combat red-hot inflation, Indian markets offered refuge to investors. Despite consistent selling by FPIs in the first half of the year, domestic flows remained resilient and helped the market (Nifty 500) close 4.2% up in 2022.
The difference between the returns actually realized by investors (investor returns) and what their investments could have earned (investment returns) is called the behavior gap. Typically, the behavior gap is negative as behavioral biases such as chasing returns and panic-selling result in investors buying and selling at the wrong times. Therefore, it is important to understand and manage the behavior gap as it can have significant impact on an investor’s long-term returns.
The behavior gap turns positive in 2022
Source: MOAMC Research, AceMF, niftyindices; Data as of 31-Dec-2021 to 31-Dec-2022
The Nifty 500 delivered 4.2% returns in 2022 despite heightened volatility due to geopolitical turmoil, persistent inflation, and rate hikes. The asset-weighted return of all equity mutual funds (including Index Funds and ETFs) came in at 2.8% and is dubbed as investment returns. This underperformance of 1.4% against the benchmark can be interpreted as the negative alpha delivered by all equity funds post management fees. However, the actual returns realized by investors turned out to be slightly higher at 3.4%, implying a positive behavior gap of 0.6%!
We believe this is primarily due to investors continuing to invest with their SIPs despite turbulent market conditions, which helped with rupee cost averaging.
For reference, the behavior gap was -2.7% in 2021 (see Annexure 1 & 2) as investors chased returns and most of the inflows came in when the market had already run-up.
Relatively stable net inflows in 2022 helped tide over market turbulence
Source: MOAMC Research, AceMF, niftyindices; Data as of 31-Dec-2021 to 31-Dec-2022; *Net flows estimated using NAV-adjusted AUM and include both SIP and Lumpsum flows.
The first 6 months of the year saw a lot of volatility in the market and the Nifty 500 fell ~10% by the end of Jun-22. Undeterred by this correction, investors remained committed with their SIPs and also showed strong participation in large NFOs during this period. This resulted in ~₹1.5 lakh Crs of net inflows pouring into Equity schemes in the first half of 2022. Therefore, Investors managed to accumulate more units when the market was trending downwards and benefited when the market recovered in the second half.
Though the momentum in net inflows reduced somewhat in the second half of the year, the SIP book continued to grow which helped negate the effects of redemptions.
Average monthly SIP flows into Equity schemes grew by 31% in 2022
Source: MOAMC Research, AceMF; Data as of 31-Dec-2020 to 31-Dec-2022; Net SIP flows for Equity schemes assumed to be 85% of total SIP book.
The simplicity of SIP investing has proven to be a great way to tide over market volatility that allows investors to cut through the noise. Over the last few years, Indian investors have increasingly adopted the more disciplined approach of SIP investing. This has led to the average monthly SIP flows into Equity schemes registering a stellar growth of 31% from ~₹8,000 Crs in 2021 to ₹10,500 Crs in 2022.
What this means is that the steady inflows from SIPs now account for a much larger share of total inflows, greatly reducing the impact of behavioral biases and emotional investment decisions on overall investor returns.
Behavior gap was positive for all categories of Equity schemes
Source: MOAMC Research, AceMF, niftyindices; Data as of 31-Dec-2021 to 31-Dec-2022; Different benchmark index used for some categories – Largecap : Nifty 50, Large & Midcap : Nifty 200, Midcap : Nifty Midcap 150, Smallcap : Nifty Smallcap 250, Others : Nifty 500
All 12 categories of Equity schemes posted a positive behavior gap in 2022. Performance of a few categories are highlighted below –
• Large & Midcap category underperformed against its benchmark by 4% and posting the largest positive behavior gap of 1%
• ELSS category posted the smallest positive behavior gap of 0.3% while it underperformed against the Nifty 500 by 4.2%
• Smallcap category showed sharp outperformance of 5.9% against its benchmark, signaling that active fund managers were able to better manage volatility in 2022. Investors in this category managed to post a positive behavior gap of 0.9%
• Index Funds / ETFs category registered a positive behavior gap of 0.6%. The benchmark return for this category is not shown as Index Funds and ETFs typically perform very similar to the index that they are tracking.
The bottom line – Stick with your investment plan
With a backdrop of geopolitical tensions, sticky inflation, and rate hikes around the world, the average equity investor in India managed to outperform their investments. The behavior gap turned positive to 0.6% in 2022 largely due to investors continuing to invest via SIPs even when the markets were turbulent. This meant that Investors accumulated more units when the market was down and benefited due to rupee cost averaging.
Though the trend of rising share of SIPs is encouraging, its important to understand that rupee cost averaging (i.e. SIP) can also work against the investors in a secular upward trending market. However, this disciplined approach to investing is still one of the best ways to minimize the behavior gap.
Over time, the behavior gap can have a significant impact on an investor’s returns, and it can be particularly detrimental for those who trade frequently or try to time the market. To minimize the behavior gap, it’s important for investors to develop a sound investment plan based on their long-term goals and risk tolerance, and to stick to that plan even during periods of market volatility. They should also avoid making impulsive decisions based on short-term market movements and seek the guidance of a financial advisor if they need help managing their investments.
This report is based on certain assumptions and estimates because accurate underlying data in not directly available. Therefore, these estimates can be considered as a good proxy but not as fact with absolute certainty.
Annexure – 1
The behavior gap was -2.7% in 2021
Source: MOAMC Research, AceMF, niftyindices; Data as of 31-Dec-2020 to 31-Dec-2021
Annexure – 2
Subdued flows in early 2021 led to investors missing out on uptrending market
Source: MOAMC Research, AceMF, niftyindices; Data as of 31-Dec-2020 to 31-Dec-2021; *Net flows estimated using NAV-adjusted AUM and include both SIP and Lumpsum flows.
Raghav Avashti – Author – Research Analyst – Passive Funds
Mahavir Kaswa – Co-author – Senior Vice President, Chief of Research – Passive Funds
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Disclaimer: This article has been issued on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this document is for general purposes only and not a complete disclosure of every material fact. The indices/stocks mentioned herein is for explaining the concept and shall not be construed as an investment advice to any party. The graph used above is to explain the concept and is for illustration purpose. The information / data herein alone is not sufficient and should not be used for the development or implementation of any investment strategy. It should not be construed as an investment advice to any party. All opinions, figures, estimates and data included in this article are as on date. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The statements contained herein may include statements of future expectations and other forward-looking statements that are based on our current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Readers shall be fully responsible/liable for any decision taken on the basis of this article. The recipient should exercise due caution and/ or seek professional advice before making any decision or entering into any financial obligation based on information, statement or opinion which is expressed herein.
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