The report, titled Starting 2026 on the Right Foot—India, draws on portfolio positioning across large-cap, flexi-cap, focused, multi-cap, large- and mid-cap, ELSS, and fixed-income categories.
Equity funds favour stability over aggressive bets
After a volatile 2025, large-cap stocks regained relative strength. Benchmark indices such as the Nifty 50 and the BSE Sensex ended the year with gains, while mid- and small-cap segments saw muted to negative returns.
Against this backdrop, most diversified equity funds maintained a relatively higher allocation to large caps, using them as portfolio anchors. Mid- and small-cap exposure remains meaningful but selective, reflecting valuation concerns in certain pockets despite recent corrections.
Morningstar said this balanced positioning allows managers to participate in potential recovery in broader markets while limiting downside risk.
Sector calls reflect domestic growth bias
A combined review of sector allocations and benchmark-relative positioning shows fund managers favouring segments with earnings visibility and strong linkage to domestic growth.
Financial services, the largest index component, remains a core allocation but is broadly neutral to slightly underweight relative to benchmarks. Within the sector, banks and non-banking financial companies are relatively underweight due to margin and asset-quality concerns, while insurance stocks are better supported on expectations of structural growth.
Consumer cyclicals are among the key overweights, with managers positioning for a recovery in discretionary spending. Autos, retail, consumer durables, hotels and travel-related businesses feature prominently, with a preference in some portfolios for auto ancillaries over manufacturers.
Healthcare continues to see overweight positioning, viewed as a defensive growth play supported by rising healthcare spending and global demand. Managers, however, remain mindful of regulatory and pricing risks.
In contrast, technology is tactically underweight across several portfolios after weaker performance in 2025, amid slower discretionary IT spending and global growth concerns. While long-term digital themes remain intact, near-term headwinds have limited incremental exposure.
Industrials are generally overweight, backed by government infrastructure spending and a multi-year capital expenditure cycle. Exposure remains calibrated due to valuation and execution risks.
Domestic flows cushion volatility
The report notes that strong inflows through systematic investment plans (SIPs) and steady domestic institutional buying helped offset foreign portfolio investor outflows in 2025. Retail participation provided stability during phases of global risk aversion, including trade tensions and geopolitical uncertainty.
For retail investors, this trend stresses the growing role of domestic savings in supporting equity markets, even during periods of external volatility.
Fixed-income funds cut duration, focus on carry
In debt markets, 2025 saw a shift in strategy as bond yields declined in the first half but turned range-bound later amid global uncertainties and heavy supply, particularly from state governments.
Although the Reserve Bank of India eased policy rates and introduced liquidity measures, the 10-year government bond yield remained broadly range-bound through the year. Shorter-tenor yields declined more meaningfully.
As a result, short-duration and dynamic bond categories outperformed longer-duration strategies in calendar year 2025.
Preference for shorter maturity
Heading into 2026, most fixed-income managers have reduced portfolio duration, particularly in dynamic and long-duration categories. The shift reflects expectations that the rate-cut cycle may be nearing its end and that returns are likely to be driven more by accrual (carry) than by sharp capital gains from falling yields.
Corporate bond exposure has increased across flexible-mandate funds. In medium-duration funds, average corporate bond allocation rose from about 46% in January 2025 to 53% by December 2025. In dynamic bond funds, it increased from 12% to 23% over the same period.
Emphasis on credit quality
From a credit perspective, funds continue to favour high-quality papers. Exposure to AAA-rated securities remains significant across categories, including medium-duration and credit risk funds, signalling a tilt toward safety and liquidity.
Overall, Morningstar said asset managers are prioritising stable income generation, portfolio flexibility and risk management in 2026 rather than pursuing aggressive duration or credit bets.
What it means for investors
For equity investors, current mutual fund positioning suggests a bias toward stability through large caps and domestically linked sectors, with selective exposure to mid- and small-cap opportunities.
For debt investors, the emphasis on short duration, high credit quality and carry-oriented strategies indicates a more defensive stance, with limited expectations of outsized gains from falling interest rates.
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