Large-cap funds, which can offer better risk-reward payoff, are seeing redemptions as retail investors are rebalancing portfolios by increasing investments in mid-cap and small-cap funds. Experts say those investors who are underweight on small-caps can rebalance their portfolios by investing in them but cautions about being overweight now. For an investment with a longer tenure, large-caps must form a significant share of core portfolios. And at this point in time, staggered investments into the segment will augur well for investors.
Large-cap active funds are increasingly struggling to beat the index even over 5-7 year time-frames, says Shrinath ML, senior research analyst, FundsIndia. “This prolonged underperformance could be the reason behind the weak flows. The outflows from large-cap funds in May could be due to some money moving into the small-cap funds on the back of strong performance of the small cap segment,” he says.
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Nirav Karkera, head, research, Fisdom, citing an internal study on SIP investments conducted during the period from April 2020 to March 2022 amidst the Covid pandemic, says that mid and small-cap funds have consistently outshined their large-cap counterparts. “This finding is further substantiated by the year-to-date data, revealing that the Nifty Midcap 150 and Smallcap 250 indices have yielded impressive returns of around 12%, while the Nifty 100 index has only managed a modest 3% return,” he says.
Large-cap strategy
This sustained outperformance of mid and small-cap funds raises concerns regarding the efficacy of returns within the large-cap category. Consequently, investors are redirecting their investments towards mid and small-cap funds in pursuit of better returns. Alongside, valuations for the mid and small-cap segment are turning favourable, further prompting inflows.
Moreover, due to a narrow universe of just 100 companies, most large-cap funds have high overlap with the index. The rising participation from institutions has led to higher market efficiency in the large-cap space. These along with the expense ratio differential, make it hard for large-cap active funds to beat the benchmark. “While some large-cap funds may still outperform the index in the future, we believe they are likely to be few and far between. Therefore, we prefer passive funds or large cap-biased flexi-cap funds to play the large cap segment for the long term,” says Shrinath.
Don’t go overweight on mid- and small-caps
While it may be tempting for investors to chase the current trend of mid-cap and small-cap stocks based on past returns, experts say a diversified investment strategy across different market capitalisations is ideal. Mid-cap and small-cap funds offer the potential for higher returns, but they also can go through phases of higher volatility. In fact, during the mid- and small-cap sell-off in 2018, the mid- and small-cap indices fell up to 22% and 35%, respectively, and the large-cap index fell only 7%.
For investors with a time horizon of 10 years or more and a higher risk appetite, allocating a portion of their portfolio to small-caps can be advantageous. “However, large-cap funds may be more suitable for those with a shorter investment horizon of 5-7 years. Including mid-cap stocks alongside large-caps in the portfolio is advisable to achieve a balanced approach. This helps mitigate risk and capture opportunities across different segments,” says Karkera.
Also read: Should you invest in multi-cap or flexi-cap mutual funds?
Multi-cap approach is suitable now
In the current market conditions, a multi-cap approach with a large-cap bias remains ideal as it helps investors strike a balance between risk and reward in the prevailing market cycle. While the large-cap segment is exhibiting signs of being overbought, the mid-cap and small-cap segments present appealing opportunities. However, investors need to exercise caution when considering mid-cap and small-cap stocks/MFs and the decision-making should not solely rely only on valuations and past returns.
For investors with an appetite for risk, Karkera says it may be prudent to start building allocations in the mid-cap and small-cap segments through a selective fund or stock selection practices. “By adopting this approach, investors can take advantage of the potential growth and returns offered by these segments while considering the prevailing market dynamics,” he says.
Investors should carefully assess their risk profile and have a longer investment horizon of at least seven years or more. Anil Rego, founder and fund manager, Right Horizons, says a multi-cap approach will be a good approach in case investors are looking to enter the markets as the mid-caps have already crossed the peak levels.
SIZE MATTERS
* Increasing redemptions from large-cap funds could be due to the category’s consistent
under-performance
* Mid-cap and small-cap funds offer the potential for higher returns, but also have higher volatility
* A diversified investment strategy across market caps remains ideal