Why large cap funds will always be flavour of investing?

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In the light of SEBI's recent mandate on re-categorization and classification of mutual fund schemes, floated in October 2017, this question is definitely worthy of being evaluated. The term "Market Cap" or "Market Capitalization" refers to the size of the company listed on stock exchanges. Market cap is one of the many factors playing an important role in strategizing stock market investments. Before we determine why large cap funds will always be flavour of investing¸ let's understand the fundamental difference between the currently existing types of funds – large cap, mid cap and small cap.

Investment in a company of a specific size comes along with its own set of opportunities and risks. Large cap funds deal with investment in equity shares of larger, well established companies having a good reputation and are generally well researched too. These companies are financially strong with the best recorded performance and excellent past achievements. They are trusted for providing steady returns to their investors. Therefore, the risk associated with large cap funds is relatively lower as compared to their mid cap and small cap counterparts. As per SEBI's circular, market capitalization will now form the basis for equity fund classification. The norm says, at least 80 percent of the funds need to be invested in large cap stocks ( top 100 companies in terms of market cap) for a large cap fund, 65 percent in mid cap stocks (companies with ranks from 100 to 250) for mid cap funds etc.

Large cap funds are beneficial for those who are looking for long term, sturdy gains with a comparatively lower risk appetite. The below graph indicates better returns in the long term derived from large cap funds.

However, according to the experts, small and mid cap funds have usually fared better than large cap funds when the market sentiment was bullish. Although, the risk appetite of the investor in this case needs to be higher since these companies are not as trustworthy or financially stable as their large cap counterparts. They are more growth oriented and aggressive in terms of expansion. Thus, market players with higher risk tolerance can possibly consider experimenting with these investment tools.

It is important to know that small and mid cap funds rank high on volatility as well, thereby making them a little less attractive for investment. Their performance is bound to get affected in bearish market, unlike large cap funds which invest in huge, credible firms and have the ability to brave bullish market too. Although they underperform as compared to mid cap and small cap funds when market prices rise or are expected to rise, they have enough money to fall back on thus maintaining their stability.

In a nutshell, it all boils down to how risk averse an investor is. The risk appetite and return expectation of an investor will ultimately help him or her, make informed choices and decide the right kind of fund to invest into. With 80 percent minimum allocation by SEBI for large cap funds as per the new norms, fund managers will have to be on the lookout for wise investment alternatives for the rest of the 20 percent. Stable corporate governance of large companies, high liquidity aiding the exit process, immunity against market fluctuations, source of fixed income for investors etc. are some of the advantages of large cap fund investment. This possibly gives them an edge over the small and mid cap funds. They tend to score high against a wide range of parameters such as capital growth, maturity, diversity, stability etc.

Moreover, large cap companies are popular and well followed, which implies that, sufficient amount of information regarding the company is available on public platforms, easily accessible to investors; this is a major trump card, as information is wealth and it can ultimately help investors take better decisions. Although, small and mid cap funds are said to have immense wealth creating potential, one should remember the high return - high risk formula. Large cap fund investors are required to stick around at least for the stipulated time period to tap full potential. Additionally, lower expense ratio of large cap funds also appears more promising. Expense ratio is the annual fee charged by funds to manage the money. It includes the fund management fees as well as the operating and marketing expenses, which is around 2.25% to 2.5% for equity and equity linked products. This should also be taken into consideration while exploring different investment options.

Another significant aspect to be looked at; is the tax on gains. The tax rate on capital gain largely depends on the holding period. For holding period up to one year, the tax rate is 15% called Short Term Capital Gain or STCG. Similarly, as per Budget 2018, new Long Term Capital Gain or LTCGs obtained from transfer of listed equity shares exceeding Rupees 1 Lakh will be taxed at 10% with no benefit of indexation.

Therefore, at the end of the day, patience is the key wherein long term gains, minimum risk and steady growth of income derived from large cap funds would possibly be more appealing to investors seeking credible money source. With big risk comes big responsibility, so the thumb rule is to be prudent and invest wisely keeping in mind your risk appetite, investment horizon and income requirements.

 

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Mutual fund investments are subject to market risks. Please read the scheme information and other related documents carefully before investing. Past performance is not indicative of future returns. Please consider your specific investment requirements before choosing a fund, or designing a portfolio that suits your needs.