The Advantages of Large-cap Funds

Listed companies in India are classified by SEBI into three categories, based on their full market capitalisation. The top 100 companies by market capitalisation are “Large-cap”; those ranked 101-250 are “Mid-cap”; and those outside the top 250 are “Small-cap”. The list is updated every six months based on the companies’ latest market capitalisation. 

Large-cap companies, i.e. the top 100 by full market capitalisation, are blue-chip companies and stalwarts of the market.

The advantages of investing in large-cap companies

• They are established businesses with sound financial records.
• They offer investors steady return potential with relatively low risk.
• They are known for generating consistent returns over time, helping investors grow their portfolios.

How to invest in large-cap companies
There are two routes for retail investors to invest in large-cap companies:

1. Directly buy company shares

2. Invest in large-cap funds

Understanding large-cap funds – and how they could work for you
Large-cap mutual funds are open-ended mutual funds that invest at least 80% of their assets in equity stocks and related securities of large-cap companies[1]. They focus your investments on these blue-chip companies to target steady returns with relatively low risk as compared to Mid-cap and Small-cap funds.

There are several benefits to investing in large-cap funds:

● Steady return potential
The average CAGR of large-cap funds hovered in the region of ~26% p.a. in 2021 (1year) and around 17% p.a. in the 3 year period ending December 2021 . While these are relatively modest returns, they have also remained steady with relatively little fluctuation[3] [6].

● Lower risk profile
Large-cap companies tend to have a strong financial foundation, capable management and established market share. As a result, these companies are better prepared to take advantage of an upswing in the economy and the markets. On the other hand, if the market tumbles or enters a bearish phase, large-cap stocks have the resilience to withstand short-term volatility. Thus, large-cap funds can add stability to your portfolio.

● Dividend income
In a large-cap fund, returns are either re-invested to enable compounding, or handed over to you if you choose the Income Distribution cum Capital Withdrawal (IDCW) option. Large-cap companies are usually profitable companies with the capacity to pay good dividends. For investors who prefer the IDCW (dividend) option, large-cap funds may be the right way to go. Do remember distribution of dividend is subject to availability of distributable surplus.

● Long-term tax benefits
Being equity-oriented, large-cap funds enable investors to enjoy tax benefits on Long Term Capital Gains (LTCG), provided they hold their mutual fund investment for more than 12 months. Large-cap equity funds enable you to enjoy tax-free returns of up to Rs. 1 lakh in a financial year. LTCG Tax on mutual fund returns above Rs 1 lakh is levied at 10%.

● Research-driven investment decisions
Since large-cap companies are typically well-established, with transparent records, they offer much more historical financial data than small-cap companies. This allows fund managers to conduct in-depth research and take the right call about investing in a company.

● High volume of trading offers higher liquidity
Large-cap equities are usually traded in higher volumes than small-cap or mid-cap equities. This allows fund managers to offload underperforming assets quickly in a bearish market, which helps maintain high liquidity.

What to keep in mind when investing in large-cap funds:

● Check the scheme portfolio
Different large-cap schemes have different portfolio compositions, so check the portfolio of the scheme you pick. An ideal portfolio should have a diverse mix of the most profitable companies, so that the volatility risk is diversified and the return potential increases.

● Know the TER
Check the TER, or Total Expense Ratio, of the scheme. It denotes the aggregate expenses incurred by that mutual fund scheme. The higher the TER, the lower the returns and vice-versa. As per SEBI guidelines, the maximum TER for equity funds is 2.25%^[4].

● Consider taxation on dividends and capital gains
If you have chosen the IDCW (dividend) option and receive regular dividends, this income would be added to your annual income and taxed as per your income tax slab rate. Returns would also be taxed as short-term capital gains if you redeem your mutual fund investment within 12 months, at an effective tax rate of 15%[5]. In the case of SIPs, each SIP instalment must complete 12 months to become eligible for long-term capital gains exemption or rebate on returns.

● Know the risk factors
Though large-cap funds are usually known to have a lower risk profile than a mid-cap fund or a small-cap fund, they are still prone to market volatility. Carefully assess the risk profile of the scheme before you invest.

● Compare the fund’s performance to its benchmark
Before picking a large-cap fund, it's important to compare its performance to its benchmark. You may look at the following key markers:

1. Alpha: A fund's Alpha compares its performance on a risk-adjusted basis with its benchmark. If the Alpha of a fund is 1, it means the fund has outperformed its benchmark by 1%. A negative Alpha would denote that the fund has underperformed its benchmark.
2. Beta: Compares the fund’s volatility with the volatility of its benchmark, the baseline number being 1. This means if the fund's Beta is 1, it is as volatile as its benchmark. The lower the Beta (below 1) the better, as this means the fund is less volatile than its benchmark.

The bottom line
Large-cap funds invest in established large-cap companies across different sectors. These funds can add just the right mix of risk and return to your portfolio, with an emphasis on stability and reliability. Investing in these funds for the long-term could be a wise move to optimise your portfolio.

Source: AMFI