Why You Need to Do a Year-End Portfolio Review

In this article, we will explore the factors at play in 2024, how they affect different asset classes, why certain mutual funds may have underperformed, and why it's time to review and rebalance your mutual fund portfolio.

The year 2024 has been a year of mixed global economic signals, which have directly impacted market performance across different sectors. Here are some of the key factors influencing the market:

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1. Global Economic Slowdown: The global economy has been facing uncertainty with slower growth projections in major economies, especially in Europe and parts of Asia. This slowdown has had a ripple effect on emerging markets like India. Inflation remains a concern globally, though central banks have worked to control it by raising interest rates.

2. Geopolitical Tensions: Geopolitical tensions in regions such as the Middle East and Eastern Europe have added a layer of volatility to the markets. These tensions often lead to sudden shifts in oil prices, which in turn affect other markets, including equity and debt markets.

3. Inflation and Interest Rates: Inflation is moderating, but it is still higher than pre-pandemic levels in several countries. Central banks have responded with higher interest rates, which affect borrowing costs and can slow down economic activity. Higher rates can have a significant impact on sectors like real estate, consumer spending, and even technology stocks, which are sensitive to interest rate changes.

4. Indian Market Specific Factors: Domestically, the Indian market has witnessed a rise in investor optimism, backed by favourable policies and improved corporate earnings. However, market corrections, particularly in the mid-cap and small-cap sectors, have led to significant volatility. With the Nifty 50 and Sensex indices showing resilience, other sectors like real estate and infrastructure have been underperforming due to higher input costs and regulatory changes.

5. Technological and Regulatory Changes: Changes in technology and regulatory frameworks, such as SEBI's new guidelines on mutual funds, have created a new investment landscape. These regulations are designed to protect investors but also require that mutual fund managers reassess their strategies, which in turn affects fund performance.

The performance of key asset classes equity, debt, and gold in 2024 has been shaped by global economic slowdown, geopolitical tensions, and monetary policy tightening. These factors have had varying impacts across markets, emphasizing the importance of a diversified and well-reviewed portfolio.

The Impact of These Factors on Various Asset Classes

• Equity Markets: Navigating Volatility

  Equity markets experienced mixed performance in 2024 due to a global economic slowdown and rising interest rates. Large-cap stocks, particularly in defensive sectors like FMCG and healthcare, outperformed thanks to their stability and cash-rich nature.

  Conversely, mid-cap and small-cap stocks faced heightened volatility, especially in sectors reliant on leveraged growth like real estate and technology. Geopolitical uncertainties, including conflicts in Eastern Europe and the Middle East, further spurred intermittent sell-offs in high-beta sectors such as banking and IT, adding to market volatility.

  As a result, large-cap funds have outperformed in relative terms, but this could change as market sentiment fluctuates. Over the past year, the Nifty 50 has grown by approximately 12%, while the Nifty Midcap 100 Index has underperformed, delivering just 6% returns. This discrepancy is significant and shows that larger, more established companies have been more resilient in a volatile market.

  Moreover, sectoral/thematic mutual funds segment, particularly in the technology, healthcare, and consumer sectors, have had a mixed year. While technology funds in India and abroad have faced pressure due to rising interest rates (which affect high-growth stocks), healthcare and FMCG funds have performed reasonably well, given their defensive nature during uncertain economic times.

  Funds like the ICICI Pru Technology Fund and Nippon India Pharma Fund have shown contrasting performances, with tech funds seeing a drop of 4%, while pharma funds have gained around 8%, benefiting from steady demand for healthcare products.

• Debt Markets: Adjusting to Tightening Cycles

  Debt markets were significantly influenced by rising interest rates and inflationary pressures. Central banks, including the Reserve Bank of India, maintained hawkish stances to combat inflation, leading to muted performance in long-duration debt funds as bond prices declined.

  However, short-duration instruments like liquid and ultra-short-term funds gained favour due to their resilience in a high-rate environment. Meanwhile, gilt funds and dynamic bond funds struggled as the yield curve flattened, limiting price appreciation opportunities.

  According to a report from Morningstar India, the average return from long-duration debt funds in 2024 has been only around 3%, compared to 6-7% for short-duration funds.

• Gold: A Safe Haven Amid Uncertainty

  Gold emerged as a strong performer in 2024, driven by geopolitical tensions and increased central bank buying. Investors turned to gold as a hedge against market volatility and inflation, boosting demand for gold ETFs and mutual funds. The depreciation of the Indian rupee against the US dollar further amplified gold prices in the domestic market. Additionally, central banks globally continued adding gold to their reserves, enhancing its appeal as a strategic asset.

Why Some Mutual Funds Have Underperformed?

Not all mutual funds have been able to keep up with market expectations in 2024. Despite their potential, certain schemes across categories have delivered relatively low returns.

The 2024 year-to-date (YTD) performance data highlights some mutual fund schemes struggling to keep pace with market expectations across various categories. As you can see from the table above, ICICI Pru FMCG Fund, part of the consumption category, has yielded a mere 1.28%, reflecting underwhelming returns despite the FMCG sector's resilience in challenging market conditions.

Similarly, sector-specific funds like the LIC MF Banking & Financial Services Fund, which posted a modest 2.76%, have fallen short amid fluctuating interest rates and evolving regulatory policies impacting the banking sector.

Coming to the category average returns, Sectoral funds under BFSI (Banking, Financial Services, and Insurance) sector and Large Cap Funds have seen the lowest gains of 13.23% and 17.61%, respectively, underperforming other equity-oriented categories.

On the other hand, categories such as Infrastructure and Pharma have emerged as the top performers, with impressive YTD returns of 31.21% and 38.85%, respectively. Mid Cap Funds (30.56%) and Technology Funds (28.14%) also posted remarkable returns, benefiting from sector-specific growth trends and market tailwinds. Similarly, Small Cap Funds, Contra Funds, and Multi Cap Funds have demonstrated robust growth with returns exceeding 25%, underscoring their potential for higher rewards in a rising market. These figures underline the importance of sectoral and category-wise diversification in optimizing mutual fund investment outcomes.

Several factors contribute to mutual fund underperformance and these vary by the type of fund and asset class. Some key reasons include:

1. Incorrect Asset Allocation: Many mutual funds, particularly those focused on mid- and small-cap stocks, have been hit harder by the market volatility. Poor allocation to sectors that are highly sensitive to interest rate changes, such as real estate or telecom, has also affected fund performance.

2. Market Timing and Style Drift: Some fund managers may have missed market trends due to incorrect market timing. A fund that is heavily invested in growth stocks may have suffered from the rising interest rates, whereas a fund manager that shifted towards value stocks earlier in the year may have outperformed.

3. Management Changes: Funds that underwent a change in fund management may have faced disruptions in investment strategy, leading to inconsistent performance. This is often the case in actively managed equity funds, where manager decisions play a significant role in fund performance.

4. Sector Concentration: Mutual funds heavily invested in a single sector or a few stocks can underperform when those sectors or stocks experience a downturn. For instance, funds focused on technology or consumer discretionary sectors may have seen underperformance due to rising interest rates and slower global demand.

Given that, such underperformance highlights the need for a year-end portfolio review to assess whether these funds align with your financial goals and risk tolerance. Rebalancing your portfolio by replacing low-performing schemes with better alternatives could ensure your investments stay on track.

Why It Makes Sense to Review and Rebalance Your MF Portfolio

Now that we've outlined how various factors have influenced different mutual fund categories, let's explore why it makes sense to review and rebalance your mutual fund portfolio at the end of the year.

• Ensuring Alignment with Financial Goals: The performance of mutual funds in 2024 might have changed the composition of your portfolio. Rebalancing helps ensure that your portfolio continues to align with your long-term financial goals, whether that's retirement savings, buying a home, or funding your children's education.

• Managing Risk: Market fluctuations in 2024 have highlighted the need for diversification. Certain sectors, such as tech or mid-cap funds, might have higher risk, whereas large-cap or debt funds could provide more stability. Rebalancing can help you manage your portfolio's risk by adjusting exposure to riskier assets.

• Tax Optimization: A year-end portfolio review allows you to look at your capital gains and tax liabilities. It may make sense to redeem some underperforming funds to book tax losses and offset gains from other parts of your portfolio. This strategy, known as tax-loss harvesting, can help reduce your overall tax burden.

• Exploiting Market Opportunities: As market conditions shift, new opportunities may arise. By reviewing your portfolio, you can make adjustments to capitalize on market trends, such as adding exposure to sectors that are expected to perform well in the coming year, like infrastructure or green energy.

At this juncture, working with a financial planner or advisory firm can provide tremendous value in conducting an efficient and thorough portfolio review. A Sebi-registered investment advisor could play a vital role in reviewing your mutual fund portfolio for the following reasons:

A SEBI-registered investment advisor could provide a detailed analysis of the historical performance of your mutual funds and help you identify underperforming funds. Using sophisticated tools, one may also assess how well the portfolio is diversified across asset classes.

Get personalized recommendations from experts based on your risk tolerance, investment horizon, and financial goals. They can suggest rebalancing strategies and recommend funds that align with your updated investment objectives.

This could help in anticipating upcoming market trends and making informed investment decisions, taking into account investor's suitability.

Final thoughts...

A year-end portfolio review is essential for all mutual fund investors. With multiple factors influencing the market in 2024, including inflation, interest rates, geopolitical risks, and sector-specific trends, it is crucial to ensure that your portfolio is well-positioned to achieve your financial goals.

Whether your mutual funds have outperformed or underperformed, rebalancing ensures that your investments are aligned with your risk tolerance and financial objectives. A year-end portfolio review will help ensure maintaining a robust and well-managed portfolio before heading into the new year 2025.

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Hiral Bhuta is a Investment Consultant & Principal Officer. She is a seasoned professional in the financial services industry, currently serving as an Investment Advisor and Financial Planner at PersonalFN. With her expertise, she plays a pivotal role as the Principal Officer appointed under SEBI's amended IA Regulation. Hiral holds distinguished certifications such as Certified Financial Planner (CFP) and NISM XA & XB, complemented by a post-graduate degree in commerce (M. Com). Her primary areas of focus encompass financial planning, investment advisory, and wealth management, where she leverages her knowledge and skills to provide tailored solutions to clients. With a cumulative experience spanning five years, Hiral brings a wealth of expertise and insight to her role at PersonalFN, ensuring clients receive expert guidance and support in navigating their financial goals.
 

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.