Equity mutual fund returns turn negative after six years of gains; should investors be alarmed?

After years of consistent growth and investor optimism, mutual funds in India have entered a rare phase of negative returns, marking the first such instance since 2018. The one-year rolling performance of equity mutual fund schemes dipped below zero by August 2025, signalling a significant shift in sentiment and performance trends across the asset management industry.

According to industry data, the average equity mutual fund return, measured by assets under management (AUM), turned negative after a prolonged bullish phase that had persisted for nearly six years. This downturn reflects both broad-based weakness across market segments and a reduction in investor risk appetite, prompting analysts and fund managers to reassess strategies amid concentrated market inflows.

Decline across fund categories

The downturn has not been limited to a few isolated funds or sectors. Instead, largecap, midcap, and smallcap schemes have all recorded negative median returns. The percentage of funds delivering positive one-year returns within each category has fallen to its lowest level since the COVID-19 market crash in 2020. Smallcap funds, which had delivered exceptional returns through 2023 and early 2024, have been hit particularly hard as valuations correct sharply.

On a one-year rolling basis, equity mutual funds have also underperformed debt funds since February 2025 — a reversal of the typical post-pandemic trend. The gap between equity and debt returns, often referred to as the “equity premium,” has narrowed to just 10%, the slimmest margin since October 2020.

Investor flows moderating

As returns falter, investor behaviour is shifting. Net inflows into equity mutual funds have slowed for three consecutive months. From a peak of ₹42,700 crore in July 2025, inflows fell to ₹33,430 crore in August and Rs 30,400 crore in September. The smallcap category, once a magnet for retail investors, saw the second-largest decline in net inflows, while thematic and sectoral funds remain under pressure.

Most new money is now being channelled into new fund offerings (NFOs) rather than existing schemes, suggesting a search for novelty and perceived opportunity in an otherwise sluggish market.

Cash holdings

Mutual fund houses are adapting by reducing cash buffers and redeploying capital into equities, particularly in midcap and diversified schemes. Industry data shows overall cash holdings dropped from 6.8% in April 2025 to 5.4% in September, falling below both the one-year and two-year averages. In absolute terms, this represents a decline from ₹19,000 crore to ₹15,000 crore, signalling a tactical shift toward market participation despite volatile conditions.

Concentration risks emerging

A growing concern is the rising concentration of fresh inflows in a handful of stocks. Nearly 25% of all mutual fund inflows in 2025 have gone into just six companies, while half of total investments are concentrated in 19 stocks. Analysts warn that such crowding increases vulnerability to sector-specific shocks and could intensify market corrections if sentiment sours further.

Outlook for investors

Despite short-term headwinds, some analysts maintain a constructive outlook for India’s equity markets. Pramod Amthe of InCred Equities noted that early signs of economic recovery and policy-driven consumption support could lift market sentiment. “We expect an 11% upside in the Nifty50, targeting 28,433 by December 2026, and have upgraded our stance to Overweight,” he said.

Brokerage Prabhudas Lilladher added that current valuations remain attractive, with the Nifty trading at 19x one-year forward earnings, slightly below its 15-year average. The firm pegs the 12-month Nifty target at 28,781, suggesting moderate upside potential.

While the current correction has unsettled investors, experts view it as a phase of consolidation and revaluation rather than the start of a prolonged downturn. For long-term investors, the message remains clear: focus on disciplined investing, diversification, and patience as mutual funds navigate a more complex, range-bound market in 2025–26.