Investments in mutual funds: Make it large

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Jinesh Gopani   |   Published 03.01.22, 03:00 AM

Selecting the right fund, sector, and composition of companies to stay invested in, is no easy task. Even seasoned investors have fallen prey to short-term market trends, losing sight of the end objective. Decisions taken rashly have severely impacted returns.

If you have been actively tracking the market sentiment for the last few months, you must have come across several reports and articles questioning the performance of large-cap funds in India.

Swayed by the returns yielded by mid and small cap funds, investors who are rushing to rejig their portfolios need to take a minute to consider the importance of large cap funds.

Before we proceed further, let’s understand some fundamental principles.

Different individuals have different goals, risk appetites, time horizons and investment corpus. The market capitalisation of a company plays a crucial role in determining the risks and benefits of investing in it.

For the ease of classification, Sebi has categorised equity mutual fund schemes into three segments based on the market cap of the companies they choose to invest in.

These are large cap funds (which invest in the 1st to 100th companies), mid cap funds (which invest in the 101st to 250th), and small cap funds (which invest in the 251st company and onwards) in terms of full market capitalisation.

Large cap funds have 80 per cent exposure to equities and the balance can be adjusted between small and mid-cap stocks.

For Long Term Goals

There are multiple reasons that make large cap funds attractive to an investor. Since they allocate 80 per cent of their portfolio (under the guidelines laid down by Sebi) towards some of India’s largest corporate houses, they provide a sense of reliability to an investor’s portfolio.

A study by Value Research conducted early this year mentioned that if one were to look at the five year rolling returns for the last 10 years, large-cap funds have returned 10.55 per cent on an average at a much lower volatility than small and mid-cap funds.

Similarly, if one were to look at the data for the last decade from December 31, 2010 to December 31, 2021, more than 50 per cent of the companies in the large cap segment have retained their position and have delivered returns (even during troubled times).

The value proposition of growth at relatively low volatility is what makes large cap funds ideal in an investor’s portfolio.

Cushion for corrections

Large cap funds comprise companies that are leaders in their own respective sectors, and offer stability during testing times in the market.

Historical data suggest that during bear market periods, large caps tend to fall a lot lower compared to their mid and small cap counterparts.

Consider the 2008 Global Financial Crisis correction: large caps corrected by 52 per cent, whereas the midcap and the small cap indices corrected by 61 per cent and 72 per cent, respectively. This is because large caps have the tendency to ride out difficult market situations due to a variety of reasons; competent and able management, large balance sheet size and longitude of presence.

Liquidity

When the market is experiencing high volatility, large cap funds provide a sense of comfort to investors owing to their highly-liquid nature.

As these companies have matured strongly over time and showcased consistency in their performance, they are ideal to mitigate risk and avoid significant losses during adverse downturns.

Fund managers can navigate the asset allocation and the weightages, without endangering business prospects.

Stability at its ‘Core’

What most investors fail to realise is that the role of large-cap funds is not to accelerate wealth in a short frame of time. They need to form a key composition of your portfolio to provide stability and security to it, thereby giving it a distinctive edge over others by outperforming the benchmark index.

Investors who are looking for long-term wealth appreciation can divide their portfolios basis on the ‘Core and Satellite’ strategies, to boost portfolio returns by keeping large cap funds at the core.

Scope for alpha generation

With the advent of passive funds, there has been multiple debates and roundtable discussions whether investors should take the active route or passive one when it comes to investing in large caps.

We believe Indian equities offer a lot of headroom for alpha generation via stock selection as our markets are a long way away from being fully efficient.

Given the changing landscape of the indices, the role of an active fund manager still holds credence in order to achieve alpha over the benchmark.

As the macro-economic situation after the pandemic is improving, investor spirits are being reinvigorated in the Indian equity market.

While there will be a few challenges ahead, the heavyweights are expected to do relatively well.

Investing in a large cap fund that aligns with your financial goals, risk tolerance, and investment horizon will add immense value in the long run.

The author is head equity, Axis Mutual Fund. Source: Axis MF Research and Motilal Oswal Research

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