Riding the storm with large Cap funds

There is a growing school of thought in the market that large cap funds are a relatively safer haven to ride the ongoing selling storm at the Indian bourses. The Securities and Exchange Board of India (SEBI) in October 2017, defined a Large cap fund as an open-ended equity-oriented mutual fund scheme that invests at least 80% of its under management (AUM) in large cap stocks. SEBI further defines a large-cap company as those listed companies which are ranked from 1st to 100th company in the Indian stock exchanges in the terms of market capitalization.

 Market capitalization is calculated by multiplying the number of a company's shares outstanding by its stock price per share. Every quarter, the Association of Mutual Funds in India (AMFI) publishes a list of the top 100 companies by market cap. Fund managers usually follow this list when making investments in large-cap stocks.

 Historically, large cap funds have provided relatively better stability to the portfolio during volatile market conditions as compared to mid or small cap funds. Since its component, large-cap companies are relatively well-established and of reasonable size, are presumed to be safer. Conversely though, on the upside, it may not offer the same growth opportunities as compared to a small or mid-cap fund.

 Since large-cap funds qualify as equity assets, any sale made within a year from the date of purchase is liable for Short Term Capital Gain (STCG) and attracts 20% tax. For any sale made after the investment has completed a year, Long Term Capital Gains (LTCG) tax is applicable at 12.5% on capital gains over Rs. 1.25 lakh.

Those investing in Large Cap funds must do so knowing that the underlying asset is equity with all its attendant risks. Yet, investing in large-cap funds is often used as a core long-term investment strategy as it is perceived to be less risky than mid-cap, small-cap, multi-cap and flexi-cap funds.

 Yet, it would be prudent to note that it is less risky only when compared to Small Cap and Mid-cap mutual funds. No equity investment is completely risk-free. Also, since risk & returns are directly related, the returns too are lesser when compared to small-cap and mid-cap funds in a market that is trending upwards.

 It is thus a natural corollary that since it is a pure equity fund, the investment should ideally be for a long period to generate better returns.

While there may be select periods where the near-term returns are superior to the long-term returns, more often than not, and particularly since the underlying asset is equity, the long term returns of a large cap fund outscore its near-term returns.

 Given the recent battering of mid and small cap stock in the Indian market following unprecedented selling by Foreign Institutional Investors (FIIs), a lot of fund managers have sought refuge in the large cap space to weather the ongoing storm. Many also believe that the rebound too will begin there from, especially given the relative valuation comfort provided by this space.

  (Ashok Kumar heads  LKW India. The views expressed here are his own)