Was FY 2022-23 a Good Year for Equity Mutual Funds? Here’s the Next Strategy for Investors

The Financial year (FY) 2022-2023 was not a great year for the Indian equity market. The Nifty 50 index declined by 3% during this period, while the broader Nifty 500 index contracted by 4.1%, as of March 24, 2023. This is in contrast to the sharp gains the indices achieved in the past two financial years.

Consequently, various categories of equity mutual funds also recorded muted returns. In this article, we will look at how different categories of equity mutual funds performed in FY 2022-23 and what should investors do about their investments.

But first, below are some of the key reasons why the equity market is ending the FY 2022-23 on a weak note:

Elevated inflation levels triggered by the Russia-Ukraine war was the biggest negative catalyst for the equity market. Moreover, the COVID-19 lockdown in China caused supply chain constraints globally, which impacted economic activities in certain sectors. To tame the elevated inflation levels, central banks across the globe, including RBI, hiked interest rates. The higher prices and borrowing costs have raised recession fears in the U.S. and other major economies. This, in turn, has darkened the outlook for global growth as it could have a spillover effect on the Indian economy and other parts of the world.

[Read: Steps to Keep Your Investment Portfolio Inflation-Proof]

FPIs turned net sellers to the tune of Rs 38,334 crore during the financial year, being wary of expensive valuations. However, strong domestic participation cushioned some losses as investors showed confidence in India's long-term growth story backed by the resilience shown by the Indian economy and India Inc.

How equity mutual funds performed in FY 2022-23?

Different types of equity mutual funds react differently to varying market conditions. Some do well during market uptrends, while others are efficient in managing downside risk.

Value and Contra Funds were the top performers in the equity mutual fund category in 2022-23. After witnessing a prolonged dull phase, value investing regained focus against the backdrop of geopolitical tensions, supply chain disruptions, inflation, central banks across the world raising interest rates to tame inflation, and heightened stock market volatility. The Value Fund category generated average returns of 2.2% during the year, while the Contra Fund category topped with average returns of 5.3%.

The Public Sector Undertakings (PSUs) and capital goods companies that were mostly neglected and trading at low valuations exhibited improvements in the past year, which boded well for Value Funds.

Dividend Yield Funds, too, performed well as dividend-yielding companies tend to be less volatile and less risky, especially during phases of intense market volatility. The category generated average returns of 1.9%.

Small Cap Funds and Mid Cap Funds outperformed Large Cap Funds, Large & Midcap Funds, Flexi Cap Funds, Multi Cap Funds, Focused Funds, and ELSS. Mid Cap Funds and Small Cap Funds generated average returns of 0.1% and 1.5%, respectively. As the Indian economy witnessed robust growth compared to many developed and developing economies, mid and small-cap stocks performed better. Notably, Mid Cap Funds and Small Cap Funds have greater exposure to capital goods, construction, and chemical companies that were among the top-performing sectors during the financial year.

On the other hand, popular categories such as Large Cap Funds, Flexi Cap Funds, ELSS, etc., did not fare so well and generated negative returns of 1.4%, 2.4%, and 1.2%, respectively. These funds invest predominantly in the Financials, IT, Pharma, Oil & Gas, and Auto sectors. A slowdown in global growth has hit the revenues in some of these sectors, especially IT and Pharma. That said, several schemes in these categories outpaced the Nifty 50 and Nifty 500 index.

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What should investors do?

Global challenges like elevated inflation levels, geopolitical tensions, and a slowdown in economic growth are expected to persist in the coming financial year as well. Therefore, it is important to set realistic returns expectation from your equity mutual fund investment. You may not see the kind of double-digit returns seen in FY 2021 and FY 2022.

It is noteworthy that IMF has opined that the outlook for Asian countries, especially India and China, has brightened as economic headwinds have faded. India continues to remain one of the fastest-growing EMEs, demonstrating promising potential. Although the challenges to global growth remain, India could benefit from improved economic activities, boosted by a higher share of the working-age population, boosting business confidence, infrastructure growth, and financial stability. This makes a case for continuing your equity mutual fund investment.

While you may see headwinds, keep in mind that the history of the Indian equity market stands testimony to the fact that after negative events such as the downturn of 2002, the U.S. subprime mortgage crisis of 2008-09, the Dubai debt debacle of 2009-10, and later the debt crisis in Greece, the slowdown in China in 2016, and the crash at the onset of the COVID-19 pandemic in 2020; the Indian equity markets have bounced back supported by buying activity from investors.

What should be your investment strategy for investing in equity mutual funds?

Given the volatile nature of the equity market, it is advisable to maintain a diversified portfolio at all times by taking into account your risk profile, financial goals, and investment horizon. Avoid taking a high risk for high returns if you do not have the appetite to handle intense market volatility.

[Read: Benefits of Diversifying Your Investment Portfolio for Your Financial Goals And How to Do It?]

Even though Small Cap Funds and Mid Cap Funds have outperformed, one should avoid investing in the categories with a short-term view. Remember that mid-cap and small-cap stocks can be highly volatile in the near term and can plunge lower than large-cap stocks during market corrections. Invest in the segment only if you have a long-term investment horizon of at least 5-7 years. It is advisable to limit your exposure to Mid Cap Funds and Small Cap Funds to under 20-30% of your equity mutual fund portfolio.

On the other hand, Large Cap Funds can offer stability to your portfolio as these funds are better placed to handle market volatility and uncertainties. Therefore, Large Cap Funds should form part of your 'Core' equity mutual fund portfolio. You can also invest in Flexi Cap Funds, Large & Midcap Funds, Aggressive Hybrid Funds, and Value/Contra Funds to potentially tap opportunities across market caps, sectors, and investment styles and benefit from diversification. If you are looking to save tax and, at the same time, create wealth through equities, consider adding ELSS to your portfolio.

Prefer the SIP route of investing, as it will allow you to invest regularly regardless of the market movement and benefit from the power of compounding wealth over the long run.

If you are looking for relatively less risky equity mutual funds to invest in a volatile market, click here. Else, if you are a conservative investor, you may consider investing in low-risk debt mutual funds.