Investing in Large-Cap Funds for Stability and Growth

Market capitalisation determines the benefits and risks of equity mutual fund schemes. Selecting the correct combinations is crucial to ensuring assured returns. When it comes to equity investments, among the key investment goals, stability and growth are common across different investor profiles. Large-cap funds combine these two factors, which makes them appealing.

How does a large-cap fund offer stable returns and growth opportunities? Read on as we explore!

What Are Large-Cap Mutual Funds?

The market capitalisation classification that SEBI has provided places funds with a minimum of 80% of the total assets invested in large-cap stocks in the large-cap segment. The large-cap stocks, often called blue-chip companies, refer to the top 100 companies in terms of market capitalisation on the stock exchange. These companies mainly consist of industry leaders, well-built business models, and robust operations.

With major characteristics, such as strong fundamentals, stable cash flows, and proven track records of these companies, these blue-chip companies are inclined to offer relatively stable returns to investors even in turbulent market conditions. Due to this, large-cap funds are usually held to be less volatile than small-cap and mid-cap equity schemes.

Advantages of Large-Cap Funds

Large-cap funds are popular picks of investment portfolios for the array of benefits they offer.

1. Lower Volatility in Relation to Other Equity Funds

Large-cap stocks, by their size and market leadership, and financial resources, tend to have lower volatility in their stock prices. For example, during the COVID-19 pandemic market downturn, the NIFTY 100 index had a drawdown of 38.1%, whereas mid-caps had a 44.2% drawdown and small cap funds had a 60.8% drawdown. This illustrates the relative stability of large caps during bad times.

2. Dividend Income

In addition to capital appreciation, large caps tend to offer stable dividends.
Looking at historic stats, the NIFTY 50 dividend yield has maintained an average of 1.25-1.5%. The 1.4% of NIFTY 50 against the 1.0% of mid-caps and 1.1% of small caps (as of October 2023) is one instance indicating a higher dividend yield in the case of a large-cap fund.

3. Long-Term Wealth Creation

Large-cap fund returns may not compare to the high returns of small-cap & mid-cap funds during bull phases, but they make up for it with steadier growth. The stability large-cap funds provide allows investors to stay invested for a longer period and profit from the compounding effect.

4. Liquidity and Flexibility

Units of a large-cap MF can be withdrawn or partially redeemed at any time, offering flexibility to investors. They can be bought either through Systematic Investment Plans (SIPs) or a lump sum, as per the investor's choice.

5. Sectoral Diversification

Large-cap funds invest in blue-chip firms in various industries, which diversifies an investor's portfolio and mitigates sector-related risk.

Risks and Considerations for Large-Cap Funds

Keep the following in mind for well-informed large-cap investment decisions:

1. Underperformance Compared to Benchmarks

Statistics in the SPIVA report indicate that for 87.5% of actively managed large-cap funds, in 2022, their performance lagged behind the S&P BSE 100 index. For a 10-year horizon, 67.9% performed behind. The repeat pattern indicates that most actively managed funds find it difficult to outperform their benchmarks, and thus, the index fund comes as a plausible substitute for large-cap exposure.

2. Moderate Growth Potential

Large-cap stability also means that in good market times, they appreciate more slowly than mid-cap or small-cap stocks. Large-cap funds gave average annual returns of 12.4% during the five years to November 2, 2023, while mid-cap and small-cap stocks gave 18.1% and 22.1%, respectively.

3. Short-Term Market Risk

Though less sensitive than other equity types, large-cap funds remain vulnerable to market fluctuations. According to historical facts, for a one-month time frame, the NIFTY 50 TRI provided negative returns 39.2% of the time. For one year, it was - 23.7%. However, the likelihood of negative returns declines steeply with increased time frames, just 0.1% in five years and 0% in ten years.

4. Other Risks

Large-cap funds are exposed to market risks arising from geopolitical or economic reasons, liquidity risks in the event of low demand in the market, and interest rate risks that affect stock valuations.

Disclaimer: Mutual fund investments are subject to market risks; read all scheme-related documents carefully.

Who Should Invest in Large-Cap Funds?

Large-cap investments are ideal for:

• New investors who wish to begin their equity investment with relatively lower risk relative to mid- or small-cap funds.

• Long-term investors who are ready to remain invested for a period of at least 5 years to take advantage of stability and compounding.

• Conservative equity investors seek more stable returns and lower volatility.

• SIP investors who want to build exposure gradually in India's largest companies.

Active vs. Index Large-Cap Funds

With the persistent underperformance of so many actively managed large-cap funds relative to their benchmarks, index funds provide a compelling solution for exposure to the large-cap universe. Index funds aim to track the performance of indices like NIFTY 50 or S&P BSE 100 and provide:

• Low cost because they have passive management

• Ease in portfolio management with no requirement for periodic monitoring

• Returns corresponding closely to the index, with a minor tracking error

Factors to Consider Before Investing

When selecting a large-cap MF, investors should evaluate:

• Expense Ratio: Lower costs mean more of the returns are retained.

• Fund Type: Active funds require monitoring, while index funds require minimal oversight.

• Investment Horizon: Large caps are not ideal for short-term goals.

• Risk Tolerance: While relatively stable, large-cap funds can still decline in the short term.

• Diversification: Ensure your overall portfolio has a healthy mix of asset classes.

Disclaimer: Please read the Scheme Information Document (SID) and Key Information Memorandum (KIM) carefully before investing.

Large Cap Fund Returns and Time Horizons

Short-term results can be concerning at times; however, long-term outcomes are rarely negative. Arge-cap funds are aimed at long-term financial growth, and they perform more consistently than mid-cap and small-cap funds over time.

For instance:

• 1-month horizon: 39.2% chance of negative returns

• 1-year horizon: 23.7% chance of negative returns

• 5-year horizon: 0.1% chance of negative returns

• 10-year horizon: No historical negative returns

Conclusion

Large-cap funds may not help you harness the bull markets like mid-cap and small-cap funds, but they can be useful when you want stable returns and growth. They have historic records of outperforming the other segments in the long term, making them ideal for long-term investments.

The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The document has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.