The Power of Diversified Equity Funds for Long-Term Wealth Creation

Feroze Azeez, Joint CEO of Anand Rathi Wealth, has highlighted the strength of diversified equity mutual fund categories in recent years. More than half of these funds outperformed the Nifty 50 from 2018 to 2025. According to Azeez, while investors might consider index SIPs, real wealth is created through SIPs into diversified equity mutual funds. He suggests an allocation of 55% in large caps and the rest in mid and small caps, which helps portfolios participate in different phases of the market cycle instead of relying on one segment alone.

Azeez also shares key recommendations on avoiding common mistakes in portfolio building and the importance of long-term investing. Edited excerpts follow:

When the Nifty 50 delivers muted returns, investors have limited scope for generating excess returns with passive index funds. Data from 2018 to 2025 shows that only 2% of index funds managed to outperform the Nifty 50. However, factor-based index funds, such as momentum, quality, and low volatility funds, have shown better performance, with more than half outperforming the Nifty 50 from 2023 to 2025.

Diversified equity mutual fund categories, on the other hand, have shown significant strength. More than half of these funds outperformed the Nifty 50 from 2018 to 2025, demonstrating how active management can generate higher returns for investors. Therefore, investors are better off opting for diversified equity mutual funds for long-term wealth creation and exposure to various market opportunities beyond the index.

Investors might invest in index SIPs, but real wealth is created through SIPs in diversified equity mutual funds. Diversifying across categories such as flexi cap, multi cap, large and mid cap, and across sectors and market caps helps avoid concentration risk. Large caps bring stability to the portfolio, while mid and small-caps add growth potential. An allocation of 55% in large-caps and the rest in mid and small-caps allows portfolios to participate in different market phases.

Investors often make emotional investment decisions, especially during market corrections. Many stop their SIPs in panic, thinking they can re-enter the market at a better phase. However, data shows that investors who saw negative returns for their SIPs in the first year saw their investments turn positive over the next four years, with returns ranging between 17-21%. This underscores the importance of staying invested and being consistent through market falls, rather than trying to time the market.

For someone earning ₹1 lakh a month, the first step is to create an investment strategy and asset allocation based on their time horizon and financial goals. Investors with a long-term horizon (over 5 years) should have equity as their core growth driver, with 80% allocated to it. The rest can be allocated to debt for stability. Investors with a medium-term horizon (1-5 years) can follow a 70:30 split, and those with a short-term horizon (less than 1 year) can invest 100% in debt. If investors wish for gold exposure, it should be limited within the debt portion. Real estate, both REITs and physical, shows lower liquidity and weaker alpha generation potential compared to equity over long periods.

There is a misconception that holding a larger number of funds means more diversification. However, without proper research, increasing the number of funds can lead to overlap and concentration risk. Smaller investors, with portfolio values less than ₹1 lakh and SIP amounts ranging from ₹1,000 to ₹4,000 per month, can invest in around 6 to 8 funds. Mid-sized investors, who invest around ₹20,000 to ₹40,000 per month, can invest in around 10 to 12 funds, and larger investors with a portfolio size greater than ₹50 lakh and SIP amounts greater than ₹50,000 per month, can hold 10 to 14 funds.

The most important rule for wealth creation is to build a proper asset allocation strategy that balances financial and physical assets. Comparisons between asset classes should be made on an apples-to-apples basis, such as CAGR. Investment decisions should not be based solely on returns but on risk-adjusted returns. For example, equity has delivered the strongest 3-year rolling returns with the highest Sharpe ratio of 0.47, meaning it provided better returns per unit of risk taken, compared to gold and silver at 0.36 and 0.20, respectively. Investors should also avoid falling into the trap of recency bias, where recent performance drives investment decisions.

Looking ahead, different segments of the market are expected to see varying earnings growth. Large caps are expected to see steady earnings growth of around 12%, while mid-caps are expected to grow at about 18% and small-caps at nearly 20% this financial year. These expectations are driven by improving consumption trends, the possibility of RBI rate cuts, and continued policy support and reforms. The Nifty 50 is currently trading below its estimated fair value by nearly 10%, suggesting that valuations are still comfortable. For long-term investors, this could serve as a good entry point. Additionally, domestic participation through DII continues to support the market, making the domestic growth story constructive over the next 12 to 18 months, even though market leadership may rotate across segments.