As we enter 2025, investors are navigating an increasingly complex market landscape. Recent market cycles have showcased both robust growth and periods of heightened volatility, making a fresh perspective on portfolio construction necessary. A three dimensional approach – Directional Buys, Diversification, and Downside Minimization – can help investors optimize returns while mitigating risks.
- Directional buys: Identifying opportunities in Indian markets
The past two years have seen impressive equity market returns across various sectors. However, investors must moderate their future return expectations, as markets tend to revert to their long-term mean valuations.
Equities: Sectoral performance and market trends
Whereas some sectors – such as the defence, PSU Bank, and PSE – have experienced significant returns over the past two to three years, others like Private Banks, FMCG, and IT have delivered relatively tepid returns. Over extended periods (12-15 years), these sectors (Private Banks, FMCG, IT) have demonstrated steady compounded growth of ~15 percent CAGR. Investors need to avoid recency bias and identify the right opportunities (Exhibit 1).
India remains a compelling long-term investment destination, but market cycles dictate that certain sectors outperform at different times. Exhibit 2 showcases that only 15 percent of companies in the NIFTY 500 have delivered >20 percent CAGR over the last 10 years vs other large economies. India still offers an opportunity to have a sharply focused portfolio coupled with bottom[1]up ideation that implies limited correlation with the benchmark. An experienced fund manager with an excellent track record across market cycles would be key to achieving the desired outcome.
For those willing to embrace higher risk, a promising opportunity lies in under-researched small-cap companies with market capitalizations below Rs.10,000 crores. In the next four to five years, we anticipate a surge of established and emerging businesses with innovative models that can deliver exceptional growth and investment potential. Capitalizing on discovery premiums and valuation re-rating will be crucial for maximizing returns in this vibrant market landscape. Here too, identifying a fund manager who has an in-depth experience in this segment and a proven long term track record would be key to unlocking nonlinear returns.
Fixed-income opportunities
The fixed-income landscape is becoming increasingly appealing. The yield on 10-year government securities has moderated since early 2024, and with the new Reserve Bank of India (RBI) governor, Sanjay Malhotra, likely to adopt a cautious stance on monetary easing, now is an opportune time for investment.
From India’s context, investors should consider shorter[1]duration debt instruments for better entry points, especially amid the current yield curve inversion (Exhibit 3). Alternatively, Absolute Return Alternative Investment Fund (AIF) strategies that combine AAA-rated liquid debt securities with derivatives can offer strong risk-adjusted returns after taxes.
2. Diversification: Strengthening portfolio resilience
Diversification remains a cornerstone of successful investing. A well-rounded portfolio should include both growth-oriented and defensive assets that can perform across different market cycles. Investors with higher concentration in listed equities would have seen abnormal returns over the last two years. One should look at diversifying across private and uncorrelated assets to reduce portfolio risk, enhance return and achieve greater resilience against market volatility.
Alternative investments: A new avenue for growth
Traditional Indian portfolios used to rely on real estate, gold, and equities. However, alternative investments (Private Equity/ Venture Capital Funds, Real Estate, Hedge Funds, and Private Credit Funds) are now gaining traction, particularly among high-net-worth individuals (HNI) and ultra-HNIs.
• The rise of AIFs:
According to SEBI, commitments to AIFs have tripled since 2020, reaching Rs.11.8 trillion by mid-2024. The Indian alternative assets market, currently valued at $400 billion, is projected to expand fivefold to $2 trillion by 2034. Private Equity and Venture Capital constitute ~63 percent of this $400 bn market, followed by Real Estate (31 percent) and Private Credit Funds (6 percent).
• Superior returns:
AIFs have outperformed traditional equity markets, generating significant alpha over five years (Exhibits 4 and 5). Within this, early-stage venture capital funds, for instance, delivered an impressive Internal Rate of Return (IRR) of 26.86 percent, outperforming benchmarks such as the BSE 250 SmallCap TRI. Likewise, the Growth and Late-stage funds’ benchmark too achieved a pooled IRR of 23.61 percent as of March 2024, exceeding BSE 200 TRI by 5.97 percent.
• Global trends in alternatives:
Globally, alternative investments have doubled their share of total assets under management (AUM) from 10 percent in 2005 to 20 percent in 2020, indicating a sustained shift in investor preference.
Uncorrelated assets for stability
Beyond equities and fixed income, some alternative assets – such as Life Settlement funds – offer stable returns with minimal correlation to traditional markets. This reduces the overall portfolio volatility, particularly during market downturns (Exhibit 6).
Globally, in developed markets, adding alternative investments have not only aided portfolio diversification but also improved risk-adjusted returns for investors (reduced volatility and better returns). This can be seen in the data shown below for the U.S. markets (Exhibit 7).
- Downside minimization: Managing market risks
Effective portfolio management requires maximizing returns and protecting capital during downturns. Emotional attachment to underperforming stocks can lead to poor decision-making, as we may wait for them to regain value. Periodically reviewing your portfolio and taking decisive action is crucial. It’s important to cut losing positions instead of averaging down, while actively supporting your winners. These steps will enhance the overall health and resilience of your investment strategy.
Rebalancing and risk control
If a portfolio’s mid-and small-cap segments have seen a disproportionate rally, it may be prudent to rebalance allocations to align with an investor’s risk profile. This could involve reducing exposure to overvalued segments and increasing allocations to defensive assets.
Long-short strategies: A shield against volatility
Long-short funds are a differentiated offering vis-à-vis a traditional equity or fixed-income portfolio. They combine long only positions in equity/debt and add derivatives to dynamically manage the net equity levels and generate superior risk-adjusted returns across market cycles. Data from 2023 and 2024 highlights (Exhibit 8) the ability of long-short funds to generate positive returns while managing risk effectively. Long-short funds highlighted in the table have better Sharpe vs pure-play equity funds. For instance:
• Long-Short Fund A delivered 23.78 percent and 21.54 percent returns in 2023 and 2024, despite maintaining only 30 percent net long equity exposure.
• Long-Short Fund B, launched in 2020, achieved double-digit annual returns with minimal drawdowns, showcasing the resilience of such strategies (21percent net long equity exposure).
Dynamic asset allocation: A smarter approach
Multi-asset and dynamic allocation strategies further enhance downside protection by adjusting asset allocation in response to market conditions. Historically, these strategies have delivered competitive returns while maintaining lower drawdowns compared to pure equity portfolios.
Final thoughts: Preparing for 2025 and beyond
The evolving investment landscape demands a strategic and multidimensional approach. By integrating Directional Buys, Diversification, and Downside Minimization, investors can build resilient portfolios capable of navigating both growth phases and market corrections.
As we move forward, the key to investment success will lie in thoughtful asset selection, tactical diversification, and prudent risk management – ensuring that portfolios remain well-positioned to capitalize on emerging opportunities while safeguarding capital.
