There have been stories in the media recently about the huge amount of cash that active equity mutual fund (MF) schemes have been sitting on lately. As of May 2024, in absolute terms, this amounted to around ₹1.17 lakh crore against ₹95,969 crore in December 2023, according to data from the financial services platform Fisdom. This sounds like a lot of money. But as a percentage of the total assets under management of equity MF schemes, it was at 5.1% in May and 4.9% in December, not materially very different.
So, active equity MF schemes continue to invest almost all the fresh inflow of money that they are seeing through the systematic investment plan (SIP) route and the one-time investment route, into stocks.
In May, equity MF schemes saw a net inflow of ₹34,697 crore, the highest ever. Further, the total amount of money coming into MFs through the SIP route stood at ₹20,904 crore—again, the highest ever. Not all the money coming into MFs through the SIP route is invested into equity MF schemes, but a bulk of it is.
In fact, regular money coming in through the SIP route into equity MF schemes clearly impacts the “mutual fund sahi hai” campaign run by the MF lobby, the Association of Mutual Funds in India, and the advertisement campaigns highlighting the importance of investing through the SIP route run by individual MFs.
And this is where an anomaly arises. But before we get into that, allow me to take a slight detour. Let’s say you are at a stadium watching a cricket match. The people sitting in front of you stand up to get a better view of the game. This leaves no choice for you but to stand up, forcing the people sitting behind you to also get up. Ultimately, this will force the people sitting in the last row to get up as well.
Now, as it turns out, economists have also thought about such a situation. As Thomas Sowell writes in Basic Economics—A Common Sense Guide to the Economy: “In a sports stadium, any given individual can see the game better by standing up but if everybody stands up, everybody will not see better.” Such a situation is referred to as the fallacy of composition or the flawed assumption that something good for a part is also good for the whole.
So, while it made sense to stand up at an individual level, on the whole, people watching the game ended up with a not-so-pleasant experience.
A similar thing seems to be happening with SIPs into equity MF schemes. At an individual level, it makes immense sense to invest through the SIP route. It essentially takes market timing out of the equation, ensuring that investors drink stocks SIP by SIP.
Nonetheless, so much money coming into equity MF schemes through the SIP route makes things difficult for fund managers. Every time they need to invest this money into stocks, chances that they end up driving up the prices of those stocks are very high. And that leads to stocks being overvalued, implying that their prices are extremely high in comparison to their expected future earnings.
High valuations
Indeed, in 2024-25, the price-to-book ratio—which measures valuation—for BSE 500 stocks, into which most of the MF money is invested, was the highest since 2007-08. This explains why quite a few fund managers have been talking about high valuations, both on and off the record, without being able to do much about it.
In fact, the flood of money coming in through SIPs, also disturbs another point at the heart of the SIP process: cost averaging. Investing a fixed amount of money every month ensures that investors buy fewer units when prices are high and more units when prices are low. In the process, they can lower the cost of the average MF unit that they buy and benefit as prices go up in the years to come.
Now, for something like this to happen, the stock markets also need to fall, when valuations are excessive, ensuring lower prices of MF units. But that hasn’t happened in the Indian market over the last few years, simply because whenever foreign investors have sold, retail money through SIP, Employees’ Provident Fund, insurance companies, and other routes has kept coming in.
So, what is the way out of this? None really. It is what it is, simply because no one really knows the future.
Vivek Kaul is the author of Bad Money.
