Equity funds' outlook for 2024: Book profits in smallcap, midcap funds

Money received should be allocated to largecap funds and fixed-income instruments

Equity funds have rewarded investors handsomely in 2023. While largecap funds (direct plans) have given a category average return of 24.6 per cent year-to-date, midcap funds have yielded 37.4 per cent. The smallcap category has outpaced both with an average return of 41.9 per cent. Amid this exuberance, retail investors should neither stop their equity investments nor get swept away by the current exuberance and invest excessively in this asset class. By sticking to their financial goals and their asset allocation, they can handle whatever the market has in store for them in 2024.

Largecap segment

Positive drivers: The outlook appears favourable for largecap stocks. 'This category appears to be relatively better placed in terms of valuations compared to the midcap and smallcap segments. Corporate earnings are expected to remain strong around mid-teen supported by a pick-up in the investment cycle and revival in rural demand (after a couple of years of weak growth),' says Sailesh Raj Bhan, Chief Investment Officer-Equity Investments, Nippon India Mutual Fund.

Currently, India is well placed in terms of macroeconomic fundamentals and is emerging as a favoured equity market for foreign portfolio investors (FPIs). 'Given the rising importance of India as a destination of choice for global capital, we anticipate higher foreign investor flows going forward. A large part of these flows is likely to go into the largecap segment,' adds Bhan.

Inhibiting factors: The key risks to this segment, according to Bhan, come from geopolitical challenges and potentially lower-than-expected earnings growth due to a weak global recovery.

Outlook: Large caps, which account for approximately two-thirds of total revenue and profitability, are well-placed to navigate difficult situations. Among largecap stocks, says Bhan, banks, and financials have trailed the broader markets over the past few years and hence can witness better investor interest given their more attractive relative valuations. Moreover, this segment, comprising established businesses with stable earnings, can manage geopolitical uncertainties with a much lower impact.

Midcap and smallcap segment

Positive drivers: Several factors have the potential to boost the performance of this segment in 2024. One is interest rate cuts. 'If interest rates are lowered, they could significantly boost growth. In India, where capital is often scarce, the Reserve Bank of India’s (RBI's) decision to cut rates can reduce borrowing costs for both businesses and consumers,' says Krishna Sanghavi, chief investment officer-equities, Mahindra Manulife Investment Management.

The other factor is lower commodity prices. 'Benign commodity prices would be especially beneficial for midcap and smallcap companies which use them as inputs,' says Sanghavi.

Many midcap and smallcap companies are involved in the capital expenditure (capex) cycle. If this cycle continues, it will provide a boost to these companies. Currently, order flows have slowed down, as happened during the six months before the general elections. It is, however, expected that the capex cycle will resume in May (post-elections), benefiting mid and small-sized companies.

Negative factors: Challenges to the midcap and smallcap segment could arise in 2024 from two fronts: earnings growth and valuations. 'The recent performance of this segment has led to high expectations for earnings growth. Valuations of mid and smallcap stocks are pricing in strong growth. Any disappointment on the earnings front could make these stocks seem overvalued,' says Sanghavi.

The midcap and smallcap segment has received considerable investment flows from retail investors. A slowdown in flows would also affect this segment. 

The way forward

Have realistic expectations: A large number of new investors enter the equity market during bullish phases, lured by its strong recent performance. 'Newcomers should approach the markets cautiously and not risk everything. They should study the market’s long-term historical performance and have realistic expectations,' says Deepesh Raghaw, a Securities and Exchange Board of India (Sebi) registered investment advisor (RIA).

Invest systematically: Opt for a phased entry into equities using Systematic Investment Plans (SIP) or Systematic Transfer Plans (STP) spread over six to nine months. 'Given the current market levels, entering gradually can mitigate the impact of short-term volatility and reduce the risk of investing a lump sum at a potentially high level,' says Pankaj Shrestha, Head of Investment Services, Prabhudas Lilladher Wealth.

If you invest a lump sum and the markets correct 25-30 per cent from current levels, you may be forced to exit equities. The experience may scar you psychologically.

Nitin Rao, Chief Executive Officer (CEO), InCred Wealth, cautions investors against stopping their SIPs at current levels as this would disrupt their long-term wealth creation journey.

Stay diversified: Investors can enhance the resilience of their portfolios by diversifying across asset classes. 'Even in a bull market, unexpected events and systemic risks can lead to significant downturns, which is why it is important to maintain a diversified portfolio with a proper allocation to debt to mitigate potential losses,' says Rao.

Feroze Azeez, Deputy CEO, Anand Rathi Wealth adds, 'Debt and equity have a low correlation. An 80:20 (if the horizon is more than five years) or 70:30 (if the horizon is three to five years) combination of these two assets can help garner double-digit returns over the long term with a reasonable level of volatility.'

Adding a 10-15 per cent allocation to gold in a portfolio that consists of equity and debt can diversify it further.

Investors who are unable to build a diversified portfolio and rebalance it periodically should go for hybrid funds. Shrestha suggests allocating to categories like multi-asset allocation funds or balanced advantage funds.

Rebalance: After the run-up in equities over the past year, investors’ portfolios would have become overweight on equities. 'Review and rebalance your portfolio to maintain your target asset allocation,' says Rao.

Valuations are getting stretched within the smallcap segment. 'Many largecap companies and some pockets of midcaps are available at attractive valuations. There is some valuation froth in the smallcap segment,' says Mukesh Kochar, National Head of Wealth, AUM Capital. He suggests rebalancing the portfolio by reducing smallcap exposure and increasing allocation towards large caps to reduce volatility in the current scenario.

Profits booked in midcap and smallcap funds may also be allocated to fixed income.

Finally, Vishal Dhawan, Chief Financial Planner, Plan Ahead Wealth Advisors warns against allocating excessively to equities, especially the midcap and smallcap segments, after the recent run-up.