Are Large Cap Mutual Funds Falling Out of Favour?

July 12, 2023 Mutual Fund

The latest data from the Association of Mutual Funds in India (AMFI) reveals that the Large Cap Mutual Fund category experienced the second consecutive month of net outflows. The outflows in the Large Cap Mutual Fund category stood at Rs 2,050 crore in June 2023 and Rs 1,362 crore in May 2023. The cumulative outflows in the Large Cap Mutual Fund category for the first quarter of FY 2023-24 was at Rs 3,360 crore. So far in the current calendar year, the inflows in the segment have been among the lowest in diversified equity mutual funds.

This comes at a time when the benchmark indices — Nifty 50 and the S&P BSE Sensex are trading at their all-time high levels.

In contrast, the Mid Cap Mutual Fund and the Small Cap Mutual Fund category witnessed record-high inflows. The cumulative inflows in the two categories for the first quarter of FY 2023-24 stood at Rs 4,736 crore and Rs 10,939 crore, respectively.

Inflows into Large Cap Mutual Funds have dwindled

*YTD as of June 30, 2023
Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully.
(Source: AMFI, Data collated by PersonalFN Research) 

What are Large Cap Mutual Funds?

The Securities and Exchange Board of India (SEBI) defines Large Cap Mutual Fund as ‘an open-ended equity mutual fund investing a minimum 80% of its total assets in equity and equity related instruments of large-cap companies’.

Large-cap companies, also known as blue chip companies, are the top 100 companies in terms of market capitalisation. Large-cap companies generally have a market capitalisation of more than Rs 20,000 crore. Some of the most popular large-cap companies include ICICI Bank, Reliance Industries, Tata Consultancy Services, HDFC Bank, Infosys, HUL, etc.

Large Cap Mutual Funds invest in companies that have a well-established brand recall value, economic moats, competitive pricing, ethical and efficient management, governance and compliance practices, solid balance sheet, and surplus cash reserves. And most importantly, they enjoy customer loyalty that helps them tide over the tough times.

Why are investors shunning Large Cap Mutual Funds?

The following could be the reason by investors are turning their focus away from Large Cap Mutual Funds:

1) Profit booking

With key large-cap indices such as Nifty 50 and S&P BSE Sensex at all-time high, the valuations in the segment have risen and are nearing the overvalued zone. Therefore, it is likely that some investors resorted to profit booking. They may reinvest when the valuations turn attractive.

2) Underperformance

Several schemes in the Large Cap Mutual Fund category have underperformed their benchmark index over the last few years. This can be attributed to several factors such as SEBI’s categorisation norms which limited the universe of large-cap stocks to top 100 companies, the single stock investment limit of 10%, as well as the availability of low-cost investment alternatives such as Index Funds and ETFs.

[Read: Should You Invest in Nifty Index Funds as Large Cap Mutual Funds Underperform?]

3) Risk-on mode

During phases of market rally, such as the one we are witnessing now, Mid Cap Mutual Funds and Small Cap Mutual Funds tend to outperform Large Cap Mutual Funds. Fascinated by the eye-popping returns, investors have been deploying their investible surplus in Mid Cap Mutual Funds and Small Cap Mutual Funds, thereby shunning Large Cap Mutual Funds. Notably, since large-cap companies are already well-established, the growth potential is limited; therefore, large-cap stocks have lower upside potential than mid and small-cap stocks.

Is it a good idea to turn the attention away from Large Cap Mutual Funds?

Large Cap Mutual Funds may not generate extraordinarily high returns because large-sized companies already hold significant market share, and therefore, they grow at a slower pace.

However, when market conditions turn uncertain and volatile, Large Cap Funds tend to offer better stability and witness lower downside risk compared to Mid Cap Mutual Funds and Small Cap Mutual Funds. Thus, investors in Large Cap Mutual Funds benefit from the steady growth of capital over the long run without exposing the portfolio to high risk.

On the other hand, Mid Cap Mutual Funds and Small Cap Mutual Funds are only suitable for investors who can handle sharp market swings. Do note that with money chasing mid and small-caps, the valuation in these segments has also run up. Smaller caps have lower liquidity, and if the momentum fades, the drawdown in this segment could be much higher than large caps. To be sure, some fund houses have recently paused or limited fresh investment in their Small Cap Funds.

[Read: Market at All-time High: Is This a Good Time to Invest in Mid Cap and Small Cap Mutual Funds?]

[Read: Why are Mutual Fund Houses Pausing or Limiting Investments in Small Cap Funds]

It would be sensible to avoid going overweight or skewing the investment portfolio to Small Cap Mutual Funds and Mid Cap Mutual Funds. Instead, consider some of the best Large Cap Mutual Funds, Flexi Cap Mutual Funds, and Value Funds as part of the ‘core portfolio’. These schemes have the ability to offer stability to the investment portfolio and potentially multiply wealth and accomplish the envisioned financial goals.

How much investors may allocate to Large Cap Mutual Funds?

Investing based on past performance is not a good idea. Investors need to evaluate their investment objective, risk profile, and investment and then take an informed decision.

Conservative investors and investors with moderate risk appetite should ideally have a higher allocation to Large Cap Mutual Funds (around 50-70% or more of their equity portfolio), and the balance can be in Mid Cap Mutual Funds, Value Funds, Flexi Cap Mutual Funds, etc.

On the other hand, aggressive investors can consider allocating 30-50% of their equity assets in Large Cap Mutual Funds.

Investors having a very short-term investment horizon of, say, 6 months, 1 year, or 2 years should avoid investing in Large Cap Mutual Funds.

This article first appeared on PersonalFN here