It is commonly understood that equity mutual fund returns and equity market returns follow GDP growth. Equities over time grow in line with the growth of underlying businesses. Economy being comprised of the businesses, the growth of the economy (real growth plus inflation) is a good proxy for the average growth in businesses.
As of 2015, the Indian economy has grown at a growth of 15% p.a. The Sensex CAGR of 17.1% is close to this 15% GDP growth. GDP growth can also be linked to the Return on Capital that businesses provide over the long term, but we will keep this simple here.
Is the converse also true?
Let’s assume people invest in the equity markets (and equity mutual funds) in spades. As a result companies have more access to capital and they are able to make investments in new capacities thereby influencing growth of the GDP positively. Also debt funds make the processes of borrowing more transparent and market driven.
So one can say that investment in mutual funds supports a virtuous cycle of higher GDP growth and therefore higher market capitalisation.
