Here's how to build a mutual fund portfolio during an economic downturn

An economic downturn is a period of time in which economic activity in a country or region declines. This can manifest in various ways, including decreased production, employment, and commerce. In addition, economic downturns are frequently followed by plummeting stock markets, as well as reduced consumer and company confidence.

People may lose their employment during an economic downturn, firms may struggle to make a profit, and general economic activity may stall. These events can potentially have a negative influence on people's lives and the economy as a whole.

Economic downturns can adversely affect your investments too. For example, your market-linked investments may dwindle in value, and your portfolio may struggle. However, you have the option to take certain actions in an attempt to offset these adverse effects. So, how do you build a mutual fund portfolio during such a time?

What is a recession?

To understand the topic better, it is essential to first understand what a recession is.
A recession is commonly defined as two consecutive quarters of negative economic growth as measured by the gross domestic product (GDP), which is a broad estimate of the total value of goods and services produced by an economy. The term 'depression” is used to describe a more severe economic downturn.
The stock market may undergo severe drops during a recession. Such drops can occur owing to various reasons. For example, as economic activity slows down, businesses may struggle to earn a profit, causing stock prices to fall. Furthermore, as people lose jobs and their incomes fall, they may be less able to invest in the stock market, contributing to drops in the market.
A fall in consumer and business confidence is another element that might affect the stock market during a recession. When people and businesses feel unsure about the future, they may be less eager to take risk and invest in the stock market, causing stock values to fall.
The stock market is volatile during a recession, and investors may suffer large losses. However, it is crucial to remember that the stock market can recover from a downturn, and certain investors may be able to take advantage of lower stock prices to purchase high-quality companies at a bargain.

What is a mutual fund?

A mutual fund is an investment vehicle that pools money from multiple individuals and invests it diverse securities, including stocks, bonds, and short-term loans. Investing in mutual funds can help you diversify your investment portfolio while also spreading out your risk.

During a recession, the performance of a mutual fund may vary depending the types of investments held by the fund. Generally, the value of mutual funds that invest in equities may fall as the stock market falls. Mutual funds that invest in other types of assets, such as bonds or cash, may be less vulnerable to a recession.

Meanwhile, many investors are understandably concerned about the potential for stock market declines and the impact of a recession on their investments. In times of economic uncertainty, some investors may turn to mutual funds as a way to protect their capital and potentially generate returns.

Mutual fund options during recession
• Low-risk funds

A low-risk, low-volatility mutual fund is one option that can be explored during a recession. These funds invest in high-quality short-term bonds and other stable investments that are less susceptible to market downturns. You may be able to maintain your capital and avoid substantial losses by investing in a low-risk fund.
One of the benefits of investing in low-risk mutual funds is that in comparison to other types of investments, such as equities, they are less volatile. This suggests that the value of a low-risk fund might not change drastically, which can reduce the likelihood of large losses. In addition, low-risk funds frequently invest in high-quality, short-term bonds. These bonds may offer a reliable source of income in the form of interest payments and are widely used as investment vehicles. Understanding the working of a bond will help you understand why they are low-risk.

A bond is a type of loan that an investor provides to a borrower, such as a firm or government, and the borrower is obligated to pay interest on the bond. You are entitled to receive interest payments on a regular basis from the borrower as compensation for their use of your money, and the principal amount is repaid when the bond matures.
Because bonds often offer a consistent rate of return in the form of interest payments, they might be an appealing choice during times of uncertainty. They can provide you a dependable stream of income, which can be especially enticing in times of economic instability. However, it is imperative to know that bonds do carry some risk. The value of your investment may fluctuate depending on various factors, including interest rates and the overall financial health of the borrower. Even then, the fact that bonds are not market-linked gives them an edge during a market downturn.

• Balanced mutual funds

Another investment option to consider during a recession is a balanced mutual fund. The portfolio of a balanced mutual comprises both stocks and bonds. Such a fund can provide diversification, the possibility of a stable income stream, and the possibility of capital appreciation.
One of the primary benefits of a balanced mutual fund is that it may assist you with risk management. A balanced fund may be able to protect against the stock market volatility by including both equities and bonds in its portfolio. In a bear market, for instance, the value of stocks may decrease, but a balanced fund's bond holdings could provide some stability and potentially help to offset any losses.
Another benefit of balanced mutual funds is that they can provide a steady income stream. The bond holdings of a balanced fund can generate interest payments that can be regularly disbursed to investors. This might be particularly appealing if you are seeking a strategy to generate income from investments without selling assets, especially during times of market downturn.
In addition to being fairly simple to maintain, balanced mutual funds are professionally managed by financial experts. This liberates you from the responsibility of selecting individual stocks and bonds, as well as rebalancing your portfolios. Instead, you can invest in a balanced mutual fund and delegate day-to-day portfolio management to the fund manager.
As with every investment, balanced mutual funds have their own set of inherent risks. The value of a balanced fund is subject to fluctuation, and you may not always receive your initial investment back. In addition, your returns may be eroded by the fees and expenses associated with balanced mutual funds. Nonetheless, they can be a beneficial tool for investors seeking to diversify their portfolios and potentially generate steady income during a recession.

• Dividend funds

A dividend fund is an investment instrument that invests in dividend-paying equities. Typically, dividend funds are mutual funds or exchange-traded funds (ETFs), and their portfolios are composed of dividend-paying stocks. The objective of these funds is to provide a steady stream of dividend income from the equities in their portfolios. Because dividend-paying equities tend to represent more solid and established businesses, dividend funds are sometimes viewed as a relatively secure investment option, even during a recession.
The general stock market tends to drop during recession, which might impair the value of dividend funds as well. However, some investors view dividend-paying stocks as a reasonably safe investment option during a recession, given that dividend-paying companies are often stable, mature, and have sound financial underpinnings. Consequently, such companies may continue to distribute dividends even during economic downturns.

• Large-cap funds

Large-cap funds are mutual funds that invest in large-cap stocks. Large-cap stocks are the stocks of companies with a market capitalization exceeding Rs. 20,000 crores. Large-cap funds are often mutual funds or ETFs holding a diversified portfolio of large-cap stocks. Large-cap companies tend to be well-established and financially solid. Thus, these funds are often considered a secure investment option. However, their prospective returns may be lower than those of small- and mid-cap funds.
As discussed above, stock markets could be largely affected during a recession. Large-cap corporations, however, are often well-established and financially solid. Consequently, it is possible that economic downturns affect them to a lesser extent than they affect smaller enterprises. As a result, large-cap funds might be able to provide some defense against financial losses during recession.

Note: Market caps are defined as per SEBI regulations as below: a. Large Cap: 1st -100th company in terms of full market capitalization

• Money-market funds

Money-market mutual funds or ETFs invest in short-term debt securities, such as treasury bills, commercial paper, and certificates of deposit. These funds are designed to serve as a relatively secure and liquid investment choice with a larger return potential than a standard savings account.
The liquidity of money-market funds is one of their major features. Because the securities in which money-market funds invest have short maturities, they can be quickly converted into cash. This makes them an attractive option for investors who require immediate access to their cash, such as corporations that must make short-term investments to pay operating costs.

Because the assets in which money-market funds invest are issued by governments and major, financially sound corporations, such funds are considered a relatively secure investment alternative. This indicates that there is a low risk of default, which helps protect the portfolio's value.
Even during a recession, money-market funds are generally viewed as a relatively secure investment option.

Buying low
Above are some of the sound options that you could invest in during a recession. However, during a recession, you need not necessarily abandon stocks and aggressive mutual fund options. Instead, you may employ the “buying low” strategy.
Typically, the general stock market exhibits a downward trend during a recession, which can have an effect on the value of individual stocks. However, some investors view a recession as an opportunity to purchase stocks at relatively low prices, with the assumption that these prices would increase once the economy recovers from the crisis.
This tactic is predicated on the hypothesis that in the long term, the value of the stock market is likely to improve. Hence, investing in stocks when their prices are low can potentially generate a healthy return on investment (ROI) when those same companies' stock prices increase in the future.
Having said that, purchasing equities during a recession exposes investors to a certain degree of risk, and there are neither returns nor security against losses as a guarantee.

Conclusion

It is usually a good idea to carefully investigate and compare several possibilities before making any investment-related decisions, especially during a recession. Moreover, it would be prudent to consider the potential risks and rewards associated with each choice and, if necessary, speak with a financial advisor.

Note: Views and opinions contained herein are for information purposes only and should not be construed as investment advice/ recommendation to any party or solicitation to buy, sale or hold any security or to adopt any investment strategy. It 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 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.

Statutory Details: Axis Mutual Fund has been established as a Trust under the Indian Trusts Act, 1882, sponsored by Axis Bank Ltd. (liability restricted to Rs. 1 Lakh). Trustee: Axis Mutual Fund Trustee Ltd. Investment Manager: Axis Asset Management Co. Ltd. (the AMC). Risk Factors: Axis Bank Limited is not liable or responsible for any loss or shortfall resulting from the operation of the scheme. No representation or warranty is made as to the accuracy, completeness or fairness of the information and opinions contained herein. The AMC reserves the right to make modifications and alterations to this statement as may be required from time to time.

Past performance may or may not be sustained in the future.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.