Large Cap Mutual Funds

As per SEBI’s classification, large-cap mutual funds are equity funds that invest a minimum of 80% of their total assets in large cap stocks.

Large caps are the top 100 companies listed on the stock exchange by market capitalisation. They are also known as blue chip companies.

Large caps are well-known giants with excellent track records and are leaders in their respective industries. Thus, they offer stable growth to their investors. For example, ITC, Reliance, HUL, SBI, etc.

Since large-cap mutual funds invest majorly in these companies, they are less volatile to market movements. Hence, compared to other pure equity funds like mid cap, small cap, multi cap funds, etc., large cap funds are low risk investments.

Among the Lowest Risk Equity Funds

Large cap funds, mid cap funds and small cap funds are among the most popular equity fund categories among investors.

But each is quite different from the other two. Large cap funds primarily invest in the largest 100 companies, mid caps in the next largest 150 (101-250) while small caps in the next largest 250 (251-500).

Because of the vintage, size and maturity of large cap companies, they are the most stable both in terms of business models as well as stock prices. This means when the market conditions are not so good for equity, large caps are least affected.

As you can see, the impact of COVID-19 on NIFTY 100 (a large cap index) was considerably lower compared to the mid cap and small cap indices.

*Drawdown is the top to bottom decline in the price of a security/index
Source: niftyindices.com, Dezerv Research 

Long Term Wealth Creation with Low Volatility

While bulk of the returns are generated from increase in stock prices, large caps also have excess cash flows which they pay out as dividends.

Historically, NIFTY 50’s dividend yield has been in the 1.25-1.5% range over the long term. This means a well-diversified large cap mutual fund can generate 1.25-1.5% returns from dividends alone.

As of Oct 2023, NIFTY 50’s dividend yield is ~1.4% whereas the dividend yield of NIFTY Midcap 100 and NIFTY Smallcap 100 indices is ~1.0% and ~1.1% respectively.

Note: An advantage of investing in large caps through mutual funds is that the dividends received by the mutual funds are exempted from tax. However, if you invest in large caps through direct equity, the dividend will be fully taxable at your marginal income tax rate.

Most Large Cap Funds Don’t Beat the Benchmark

Over the years, it has become difficult for the fund managers to outperform their benchmark index.

According to the SPIVA report, 87.5% actively managed large cap funds have underperformed the S&P BSE 100 index in 2022. Furthermore, for a 10 year period, 67.9% of the large cap funds have underperformed their benchmark.

SPIVA -> S&P Indices Versus Active Funds

The above is not a one-off instance. As per SPIVA reports, a large majority of active large cap funds have been underperforming the S&P BSE 100 index over various periods, short and long, for many years now.

Good, but not great returns

We saw that large caps are not as badly affected by market crashes as mid and small caps thanks to their stable business models and cash flows.

While stability is a good aspect of large caps, it works against them during favourable market conditions or bull runs and even in the long term.

During favourable market conditions, mid caps and small caps rise faster than large caps. Since India is and has been on a growth trajectory for decades now, even the long-term performance of mid and small caps surpasses large caps by a distance.

The table below shows the average returns of large cap, mid cap and small cap funds over the last 5 years (ending 2 Nov, 2023).

Not suitable for the short term

We saw that large caps are among the most stable businesses which makes their stock prices relatively stable too.

But large caps are stocks at the end of the day and subject to the short-term turbulence of the stock markets. So, large cap funds are meant for long-term investments (5+ years).

Short term investments in large cap funds can have extreme results, good or bad. Here’s an illustration for NIFTY 50 TRI:

Period considered: June 1999 to Oct 2023

As you can see, there’s a significant chance of generating negative returns over short-timelines like 1 month and 1 year.

However, as you extend the investment timeline and stay invested for longer periods, the chance of generating negative returns reduces drastically.

As we saw, actively managed large cap funds have been underperforming for many years now. Thus, it makes more sense to invest in large cap index funds than investing in active large cap funds to get large cap exposure in your portfolio. 

So, let’s look at why you should consider investing in large cap index funds:

New to investing

If you are new to investing, mutual funds are perfect to start your journey. 

Large cap index funds help you invest in India’s largest companies with the most stable businesses and stock prices. This means the risk involved is among the lowest when compared to other equity funds.

Low-effort, long-term investing

Different active funds have varying performance across market cycles. But this is not the case with index.

If you invest in an index fund, you are not only simplifying your portfolio but also making it future proof. This is because index funds don’t necessarily require holistic and periodic reviews like active funds.

Keeping an eye on the ‘tracking error’ of your index fund is sufficient. Tracking error is the difference between the return of the index fund and the index it tracks that arises primarily due to the expense ratio of the index fund.

Low cost investments

Index funds are passively managed and have a low expense ratio. Lower the expense ratio, higher your returns.

Note: The above information is for educational purposes only. It is best to consult a financial advisor before making investment decisions.