Mutual Funds: Second thoughts on large-cap funds?

By: |
November 01, 2021 6:15 AM

As it is getting difficult for large-cap active funds to outperform their benchmarks, investors can choose passive funds as they mirror the index returns

Investors’ appetite for large-cap funds is falling as net inflows in this category in September was only Rs 14 crore, one of the lowest in the equity-mutual funds segment which mopped up Rs 8,677 crore in the month.Investors’ appetite for large-cap funds is falling as net inflows in this category in September was only Rs 14 crore, one of the lowest in the equity-mutual funds segment which mopped up Rs 8,677 crore in the month.

At a time when the benchmark indices—30-share BSE Sensex and 50-share Nifty—have doubled from the lows of March last year, the performance of most large-cap mutual fund schemes has not been encouraging and the schemes are losing their sheen. Around half of the existing large-cap schemes of mutual funds have underperformed their respective benchmarks in the last one year and even more in the longer five-year period. Investors’ appetite for large-cap funds is falling as net inflows in this category in September was only Rs 14 crore, one of the lowest in the equity-mutual funds segment which mopped up Rs 8,677 crore in the month.

Experts say in the last couple of years, while the benchmark indices rallied, not all large-cap stock gained. As a result, actively managed funds where high weights are given to few outperformers are not able to generate the alpha. Moreover, quite a few growth-oriented stocks are now trading at high valuations impacting the returns of large-cap funds in the short-term. Coupled with these factors, the market regulator’s classification norm for mutual funds made it difficult for large-cap funds to generate the alpha as these funds were mandated to invest in top 100 companies by market capitalisation.

Investing in large-cap funds
So, should you continue investing in large-cap funds, which are considered safer than mid- and small-cap funds? Experts say an investor must have allocation to large-cap funds in the portfolio as they provide better protection against volatility compared to mid- and small-cap funds. At a time of market correction, mid-and small-cap funds are the worst affected than large-cap funds. In fact, as investors fear that the bullish momentum in mid-and small-cap funds could see a reversal for a longer period, they are now increasing their allocation to multi-cap funds.

Before selecting a large-cap fund, see whether the scheme has been able to capitalise on the shift in the sectoral rotation over a longer period of time. Moreover, investors should analyse whether the fund manager follows the buy-and-hold strategy or churns the portfolio. If the churning is frequent, then the fund manager does not have conviction in his stock selection. Investors will have to be very selective in large-cap funds and invest in those that have active management of stock weights.

Analysts say if any large-cap fund in the portfolio has underperformed for a long-time, then one must exit the scheme and invest in a better performing scheme as the equity market will broadly continue to offer alpha generating opportunities for better managed funds. Well-managed large-cap funds have created significant long-term wealth for investors in the past and will continue to do so, going ahead.

Go passive
If selecting an active fund is a challenge, go for passive funds such as Nifty 100 and the Nifty Next 50 as they mirror the index returns. The passive funds will ensure a stable large-cap component in the portfolio that will work in line with the market and give higher returns.

In fact, fund houses are launching a host of passive funds across categories as investors are increasingly opting for passive funds because of lower costs and higher returns than active funds. As it is becoming difficult for fund managers to generate the alpha in actively managed funds, especially the large-cap ones, asset management companies are lining up new fund offers in the index funds. Moreover, young retail investors are preferring to invest in passive funds launched by fintech platforms because of the ease of investing. All exchange traded funds have to be bought only in demat accounts, a preferred mode by new-age investors.

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