Indian Sectoral Mutual Funds Face Momentum Shift as Two-Year Returns Stall
While over a third of Indian equity mutual funds doubled investor money over five years, recent two-year stagnation signals a cyclical shift that demands a strategic pivot toward diversified portfolios.
Over the past five years, 101 of 310 Indian equity mutual funds generated absolute returns exceeding 100 percent, excluding international schemes. However, recent two-year performance data reveals a sharp deceleration across these same top-performing sectoral funds.
Infrastructure and public sector enterprise themes led the historic rally. The ICICI Prudential Infrastructure Fund posted a 188 percent five-year return, closely trailed by the SBI PSU Fund and LIC MF Infrastructure Fund at 183 percent. Yet, over the past two years, these same funds delivered returns ranging from a marginal 0.75 percent gain to a 3.51 percent decline.
This divergence highlights the danger of chasing historical rankings. Azeez of Anand Rathi Wealth noted that funds can retain impressive long-term metrics even after their underlying themes enter consolidation. He warned that a meaningful part of the recent rally has already been captured, and investing after a strong rally often increases the risk of entering at the peak.
The earlier outperformance was driven by robust policy support and earnings growth. Sustained government capital expenditure, including a record 1.8 lakh crore rupee allocation for the defence ministry in FY26, fueled infrastructure and defence stocks. Healthcare and small-cap segments similarly benefited from production-linked incentives and improving corporate earnings.
Despite the recent slowdown, long-term structural drivers remain intact. Azeez pointed out that healthcare and infrastructure retain healthy earnings-growth potential over the next two to three years, while defence and PSU companies maintain sufficient earnings visibility. He also highlighted that the Nifty Smallcap 250 currently exhibits "negative froth" of 15.5 percent, with earnings projected to grow 20 percent in FY27 and 18 percent in FY28.
Consequently, market strategists are advising a shift away from concentrated sector bets. Azeez recommended that retail investors access these opportunities through diversified equity vehicles, such as flexi-cap or multi-cap funds. This approach allows professional managers to adjust sector exposure dynamically as valuations and earnings prospects evolve.
Institutional fund managers agree that the broader market cycle offers fresh entry points. Chandraprakash Padiyar, Senior Fund Manager at Tata Asset Management, stated that the current earnings cycle remains at a relatively early stage. His firm has been accumulating large- and mid-cap re-rating candidates in healthcare, power, and financial services.
Shridatta Bhandwadar, CIO-Equities at Canara Robeco Asset Management, echoed this sentiment, noting that large-cap valuations at 17 to 17.5 times estimated FY28 earnings are reasonable compared to historical levels. He advised that near-term volatility from geopolitical or monsoon uncertainties presents attractive opportunities for investors with an 18 to 24-month horizon.
