Mutual Funds and Impact of Economic Indicators

What are Economic Indicators?

Economic indicators are statistical data collected and released by several government agencies. They help gauge how an economy is performing and project future estimates of economic progress through data reflected in the indicators. Several economic indicators help track an economy’s performance.

Economic Indicators and Their Impact on Mutual Funds

Now that you know what are economic indicators let’s see the various indicators and their influence on mutual funds:

1. Gross Domestic Product

Gross Domestic Product, or GDP, as it’s known, is one of the most widely used economic indicators. It showcases the total value of goods and services within a specific time frame. A high GDP indicates a strong economy and expresses a generally bullish sentiment in the country. High GDP can lead to strong corporate growth, which in turn, can uplift a mutual fund’s performance.

On the contrary, a shrinking GDP indicates that the economy is struggling to maintain growth, and companies cannot generate enough profits. This negatively impacts mutual funds and brings down their returns over the long term.

2. Interest Rates

Interest rates are another key economic indicator. The Reserve Bank of India (RBI) sets interest rates as a part of its monetary policy. Recently, when inflation was above the RBI’s comfort level, it raised key interest rates to bring it down. Note that bond prices and interest rates share an inverse relationship. It means bond prices come down when interest rates go up and vice versa. So, bond holdings in mutual funds tend to suffer in a high-interest rate regime.

Also, raising money from the market becomes costly for companies when interest rates are high. At the same time, it becomes expensive for them to serve their existing loans, and their profits take a hit. In such a scenario, a company’s financials suffer, and this affects the performance of funds that have such companies in their underlying portfolio.

3. Inflation

High inflation erodes money’s purchasing power and significantly impacts fixed-income funds. If interest rates fail to keep pace with inflation, the real rate of returns may be lower. Also, during such times, the RBI increases key policy rates, such as the repo rate, to control inflation. When it happens, bond prices fall, and a fund’s performance may suffer.

At the same time, news about high inflation hurts investors’ sentiments, and they get spooked. They tend to stop their investments or withdraw money in such a scenario. If it happens, it has a negative impact on a fund’s performance. On the other hand, when inflation is under control, it sends positive vibes among investors and makes them more confident in their investments.

4. Employment and Income Levels

The level of employment and income affects consumer spending and corporate earnings. This, in turn, affects the performance of mutual funds. Robust levels of employment and income have a positive impact on funds. Note that consumer spending is a key driver for several sectors and impacts a company’s inflow. Mutual funds tend to benefit if it’s on the higher side.

5. Currency Exchange Rates

If you’ve invested in an international fund whose underlying securities comprise foreign companies, currency exchange rates can affect its performance. For example, if you have invested in a fund primarily investing in US-based companies, an appreciation of the dollar will improve the fund’s performance. On the other hand, if the dollar experiences a depreciation, it can have a negative impact on the fund.

In Conclusion

As evident, economic indicators have a significant say in the performance of mutual funds. As an investor, it’s essential for you to keep a tab on them and align your mutual fund portfolio accordingly. Track these indicators from time to time and make the necessary adjustments.