SIP vs Lump sum in mutual funds

[raghav29]

Hello everyone,

This is my first post here. I did a small experiment and thought of sharing the result with you guys.
I invested in Franklin India Taxshield Fund - Direct Plan about 3 years back, five lumpsum of small amount over a period of 4 months.

As you can see, these investments were haphazard.

The CAGR comes out to be approx 12.21% for a period of three years. A decent 41% return. (It is a crude estimation of the number of years)

On the other hand, if I had invested through Rs 1000 SIP monthly from 1st August 2015 - 1st July 2018, I would have had approximately 22% return at a CAGR of 6.84%

If I check the 3 year return of the fund, it is 9.71%

Are SIPs a good way to invest or should we rather put a single lumpsum and forget about the investment or time the market and put 3-4 lumpsums when the market is falling?

Note- These are very crude estimations regarding the time period. However I believe that by varying it by a couple of months would give an approximately same result.

[us121]

It is too small time span to make this comparison. Also when market mood changes few months here and there makes huge difference in outcome. For such calculation i will look for ideally 10yrs of time, but nothing less than 5 years.

If same duration u would hv started from 2006 to 2009 results will throw different outcome.

[raghav29]

I agree that 3 years is not ideal time for comparison. However, I believe 2015-18 was a bull market with a few hiccups and the comparison I have made is for the same fund during the same period in all 3 scenarios

[drgrudge]

We don’t know how long you will stay invested. Probably even you might not know. In the very long run, say over 20 years, it would not matter how you invest (SIP or lump sum) and even at what price you invest.

I stay invested in ELSS only for three years, irrespective of the returns, and re-invest the proceeds in direct equities. I don’t bother with timing the market. I spend my energy for my direct equity portfolio. I feel SIP is wonderful not because it is reduces risks (it doesn’t) or enhances returns (maybe not) but it is automated and I don’t have to worry on the petty work of timing the market for investing small sum of money in relative to my PF size.

[ankit1511]

@raghav29,

There is no doubt that all other things being equal, investing lump sum at lows is more rewarding than SIP investments in the same time period — be it in specific stocks, mutual funds, or the index.

But I think the one trait that gets overlooked in most such analysis I have seen is the size of the bet. If the lump sum bet at the lows is not a meaningful chunk of one’s net worth, then it is not worth it. Teaspoon sized investments might give an investor the ego boost of having generated superior percentage returns but will not result in any meaningful wealth creation. The same is also true for SIPs with the only difference being that averaging dilutes the volatility and gives some investors the confidence to make bigger equity allocations. So even if the percentage returns are lower, they generate higher absolute returns than someone who bought at the low but did not buy enough.

What investment corpus is big and what is small is something that is specific to each investor so there is no way of defining that in absolute terms but it has to be enough to help the investor move forward on the path of financial independence, if the bet works out fine.

The above is, of course, in addition to the patience required to wait for cyclical lows when others are making money and then the conviction required to bet big when the chips are falling around you.

I hope this helps.

[ruffles]

Very good response. I am able to bring courage for bigger bets but don’t have patience to wait for

“patience required to wait for cyclical lows when others are making money and then the conviction required to bet big when the chips are falling around you.”

How do you practice this.

[vij]

A simplification one could consider… if market is near 52 week lows, go lumpsum… If near 52 week highs go sip.

[raghav29]

That was very helpful. Thank you for the superb reply.

[ankit1511]

@ruffles,

Building conviction is a by-product of voracious reading, in my view.

Two indomitable facts emerge if you study the history of businesses and financial markets worldwide:

1. It is very difficult for an investor to make returns that are very different from the growth in earnings and RoE of the underlying asset (business) that she/he holds.

2. Reversion to mean is one of the few certainties in an otherwise volatile and uncertain business of investments.

If you combine the two, it becomes clear that no matter how exuberant or depressed valuations may be at a given point in time, they will revert to their mean sooner or later. Now, the mean will be lower if market participants are feeling greedy (as is currently the case) or higher if investors are generally feeling depressed (as was the case a decade ago). Timing it is impossible but either ways, the reversion will happen. That to me is the biggest source of conviction for being patient in waiting for dips and then buying when things look ugly.

That said, there is one important point to keep in mind, i.e., the valuation of the market has no bearing on the business that you may want to own. So, it is perfectly ok to buy good businesses if they are attractively priced, no matter how high the valuation of the index is. Similarly, it is not a good idea to buy a business which is expensive just because the index is trading low. It is common for investors to look at index levels while investing in individual stocks, which is a fallacy in my view.

Mutual fund and index investors, however, can use index levels as a guide if they can bring the courage to invest big when there is a serious correction. This, of course, doesn’t apply to thematic or cyclical funds, whose business cycle can be completely different from the index’s earnings cycle.

One way to judge how your own investment style is to look at the movement in your cash levels. Generally, cash levels should be highest when valuations are expensive and should be the lowest when things are cheap. The behavior of most investors and mutual funds, however, is the complete opposite as cash calls increase when the market falls (you will hear chants of preservation of capital) and buy calls increase when asset prices are rising. Therein lies the opportunity for good investors to deploy capital and generate above-average returns.

I hope this answers your question.

[ruffles]

Thank you Ankit. One issue with falling price of a stock may be the business has deteriorated. Take case of textile companies like Welspun India, Trident, Indocount all of them are low at the moment. Now what we should think are they available at cheap or business is facing headwinds in terms of retailers are destocking, rising raw material cost. These headwinds could last for long and so prices will stay low for long. Investor will loose the patience and move to the stocks which are in demand.

[ankit1511]

@ruffles,

The businesses you cite are all cyclical in nature. Investing in cyclical businesses like Textile, Sugar, Steel, Cement, etc. is very different from investing in secular businesses like Staples, Consumption, etc.

Earnings of cyclical businesses go through steep crests and troughs in one complete business cycle – they look great when the going is good but fall drastically when the cycle turns. This is because their top-line shrinks due to 1) cyclical drop in demand and rise in raw material prices; 2) oversupply which leads to heightened competition; and 3) fall in per unit pricing due to a combination of the first two factors. This creates negative operating leverage for these companies and their profits decline significantly. The situation is worsened when most companies are busy executing their capex and expansion plans, which hurts profitability even further.

So, while investing in cyclicals is extremely profitable, the business cycle of cyclicals should not be judged from the demand-side since demand if very hard to predict. Rather, you should look at supply-side indicators. The right time to buy them is 1) when you see consolidation happening in the sector (M&As); 2) capacities shutting down as weaker players find business unsustainable; 3) capex phase for good players nearing an end; 3) RoEs at cyclical lows; 4) P/Es looking extremely high due to depressed profits; and 5) huge operating leverage created on balance sheets (asset turnover will fall).

The other important point in cyclical investing is that while you can adopt a buy and hold strategy for secular businesses, you can’t do that for cyclical ones. As their earnings rise and fall in a cycle, so does their stock price. So, if you hold them for a complete cycle then you will just about get your money back or make modest returns which might even be lower than what you can get through fixed income instruments. You have to buy when the supply-side indicators line-up and sell at highs leaving some profits on the table because predicting exactly till when the demand upsurge will last is tough, if not impossible. One early indicator to start selling is when the P/Es start looking normal and you hear people talk about how these businesses have become secular stories that will grow indefinitely into the future.

Coming specifically to the textile exporters, the issues that have hurt them in the last 8-10 quarters, in my view are: 1) downturn in demand after the upsurge in 2010-2015; 2) cyclical upswing in cotton prices; 3) heightened competition from African, Bangladeshi, and Pakistani players; 4) 2017 was bad from a regulatory perspective with GST + withdrawal of duty benefits + no FTA with EU; 5) poor performance of end-clients (U.S. retailers) due to competition from Amazon (this led to de-stocking and even bankruptcy of some retailers); and 6) capex by these players to expand capacity and build B2C brands. The result has been poor earnings by large players while smaller players in Surat etc. are struggling for survival and are shutting down shop.

Now, if you evaluate the current situation, the GST + duty issues have been resolved and the revised import duty should also help a bit. Dollar has strengthened against the INR. Capex spending seems to be more than half done, if not more. U.S. economy is on the mend and performance of end-clients is bottoming out though I am not 100% sure about their ability to compete against Amazon (the comments of Welspun and Indo Count are divergent on this point) – this is a key monitorable for me and could affect my decision to buy these businesses or not since this is not a cyclical issue, rather a structural one. I do expect some consolidation in the sector before the down cycle ends. So while we still do not have all ducks lined-up in a row, it is safe to assume that we are closer to the bottom of the cycle than the top. I personally expect things to look better 2019-20 onward and am monitoring it closely. But as I said, timing it is impossible (one always gets it wrong) so you need to focus on players that have the balance sheet strength to survive even if the downturn lasts one or two years more than you expect.

I hope this helps.

Disclosure: I am not a registered investment advisor so please do your due-diligence before making any investment decisions. I currently do not own any of the stocks discussed above but am monitoring them. I may or may not add them to my portfolio at any time.

[ruffles]

Thanks for an elaborate answer. In general Cyclical industries must be looked in this way.

Coming to textile industry, I have made good money in Welspun and it made me serious about stocks. If you think about their de-stocking issue it will not come back to normalcy. Online retailer will stay and increase in times to come however these companies have now one more channel to sell. They can sell to online retailers(amazon and eCommerce sites of offline retailers).

In my opinion, why their Sales volume are down is very main issue. May be someone else is expanding market share my guess is China, or other Asian countries are eating pie from them.

These companies are trying to increase market share in institutional and hospitality sector where china is dominant. This market is big if they can be competitive in this it would leap their sales.

End user demand is more or less same, Cotton prices and crude prices are not going to be low for near foreseeable future so the stock prices could be at bottom but gain in stock prices is still far unless they seek new channels or new products.

I think looking at margin trends of these companies can definitely tell if raw material cost trend is rising or going down.

Consolidation i am not sure did you see Textile companies buying other companies in India.