Investors must tilt portfolio towards quality amid market volatility

Mutual fund investors should maintain a diversified portfolio and continue with their SIPs

On January 6, 2025, the BSE Sensex dropped 1,400 points, while the Nifty declined by 400 points. Many retail investors are encountering their first bouts of sustained volatility in the market. Here’s how they can navigate this phase.

 

Drivers of volatility

 

According to market experts, exaggerated valuations, lifetime-high indices, lower-than-expected corporate earnings, and geopolitical tensions have affected market stability. 

“Concerns over the spread of the new human metapneumovirus (HMPV), subdued updates ahead of the Q3 earnings season, alongside global economic headwinds, have led to heightened volatility in recent months,” says Shreyash Devalkar, head of equity, Axis Mutual Fund.

 

Global tariffs and strong dollar

 

US President-elect Donald Trump’s ‘America First’ policies, including lower corporate taxes and higher import tariffs, are expected to spur US growth but could also increase inflation, interest rates, and strengthen the dollar, says Devalkar.

A stronger dollar exerts pressures on emerging market currencies, including the Indian rupee. Still, Devalkar remains optimistic. “US tariffs on China may indirectly benefit India due to the ‘China Plus One’ strategy. Export-oriented sectors, like IT and pharmaceuticals, may see margin improvements due to a weaker rupee.”

 

Fund outflows and earnings slowdown

 

After strong foreign portfolio investor (FPI) inflows in 2023, the trend reversed in 2024, with outflows totalling $13.5 billion in October and November, driven by a strong dollar, high valuations of Indian equities, and stimulus measures in China.

“A slowdown across consumption, capital expenditure, and exports led to muted earnings growth,” says Devalkar. Despite this, he anticipates moderate recovery by FY26 as government spending improves.

 

Sectoral opportunities in 2025

 

Opportunities may emerge in IT, pharma, quick commerce, renewable capex, power transmission, and defence, though valuations remain high, says Devalkar. Stable earnings and better execution by US-focused generic pharma companies could sustain growth in the pharma sector.

Experts also expect the IT sector to rebound, supported by stronger US banking, financial services, and insurance (BFSI) sectors and possibly favourable US policies.

 

Why investors should stay invested

 

Investors should prioritise time in the market over timing it, says Jatin Khemani, managing partner and chief investment officer (CIO), Stalwart Investment Advisors LLP. He warns against chasing high valuations in small- and mid-cap stocks. “Strong flows chasing the same set of stocks have captured most positives, reducing the likelihood of sustaining such returns in the future,” he says. 

Khemani advises focusing on large-caps while reducing exposure to smaller-cap stocks due to risks like execution and governance issues.

 

Sector-specific rebalancing

 

The BFSI sector, which contributes a third of the Nifty’s profit pool, may perform better in 2025. Large private banks and standalone health insurers look attractive for the next three–five years.  “Current valuations are reasonable, and when the earnings cycle turns positive and FII outflows reverse, the upside can be disproportionately higher," says Khemani.

 

Avoid poor-quality stocks

 

Many investors are tilting their portfolios towards large caps. Manish Bhandari, chief executive officer (CEO) and portfolio manager at Vallum Capital Advisors, emphasises quality of business and valuations over market capitalisation. “What matters in the long term long term is whether the business is good and the stock price is fair,” he says. 

While weeding out poor quality stocks is essential, frequent portfolio shifts often lead to buying high and selling low. Instead, investors should regularly evaluate portfolios at turning points, focusing on business models and valuations, suggests Bhandari.

 

Mutual fund investors: Exercise caution

 

During the bull run, many investors bet heavily on sector and thematic funds. Arun Kumar, head of research at FundsIndia, cautions against overexposure to these funds, which require perfect timing. “Sector funds are highly volatile and concentrated. Limit exposure to 10–20 per cent of your portfolio,” he advises. 

Kumar and Khemani also warn against the high valuations of mid- and small-cap funds. “We recommend limiting exposure to small caps to less than 10 per cent and mid- and small-caps combined to 25 per cent of a portfolio,” says Kumar.

 

Diversification across asset classes

 

Kumar highlights the importance of diversifying across equities, debt, and bullion. “Debt offers stability, while gold performs well when equities falter,” he says. Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors adds that diversifying geographically into international equity exposures can reduce volatility. He believes that gold remains a valuable hedge against geopolitical risks, despite strong performance in 2024.

 

Market volatility: Get accustomed to it

 

Regular corrections of 10–20 per cent are normal, says Dhawan. “The challenge arises when investors expect markets to be in a constant bubble or face catastrophic falls,” he says. 

Stopping systematic investment plans (SIPs) during downturns would hurt investors’ long-term returns. “SIPs allow investors to benefit from rupee cost averaging,” says Kumar. Significant market corrections, such as over 20 per cent, can present buying opportunities, he adds. 

Tips for mutual fund investors on dealing with turbulent markets

• Avoid exiting the market during turbulence, as you might miss out on the recovery rally
• Continue your systematic investment plans (SIPs) to benefit from rupee cost averaging
• Seasoned investors should consider international funds, such as US equity funds, to benefit from low correlation with domestic markets
• Ensure diversification across investment styles (e.g., momentum, quality, value) and market capitalisations within the domestic market
• Diversify into debt funds to enhance portfolio stability
• Rebalance your portfolio when equity exposure deviates by 5 percentage points from its original allocation by shifting funds from debt to equity