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Should you invest in Large Cap funds despite low returns compared to small and mid-caps?

large cap investing

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With large-cap funds giving lower returns than small-cap and mid-cap mutual funds, many investors want to know whether they should continue to have large-cap funds in their portfolios or not. In an online Q&A with FE Money recently, Chintan Haria, Head of Investment Strategy at ICICI Prudential AMC shared why investing in large-cap Nifty50-based funds makes sense. He also talked about why the Nifty50 index is considered the ideal way to have exposure to large-cap stocks. Edited excerpts:

Why is the Nifty50 index considered the ideal way to have exposure to large caps?

Nifty50 index consists of 50 of the largest Indian companies in terms of market capitalisation that are listed on the National Stock Exchange. Spread across 14 different sectors, the companies present in the index are the leading and the most profitable names in their respective sectors. Also, since the index is rebalanced semi-annually, an investor can rest assured that they have steady exposure to the 50 best companies available in the listed universe.

For investors looking to invest in Indian equities, a Nifty 50 index fund or an ETF can be a good starting point. Similarly, for large-cap exposure in a portfolio, investors can consider an index fund or the ETF based on the Nifty 50 index.

Returns from Large Cap funds have been lower compared to mid and small caps. Why should investors still consider having large-cap funds in their portfolios?

From a portfolio perspective, large caps have a distinct role. A large-cap offering will comprise of some of the most established businesses in their respective industry. These companies will be stable in nature, with a robust balance sheet and better corporate governance standards. As a result, large caps by nature have the ability to deliver steady returns and tend to be less volatile in nature. So, if an investor is looking for stable returns which are less volatile in nature, then large-cap funds are more preferred.

In comparison, mid and small caps are relatively small in size but tend to hold high growth potential as these companies are the future large caps in the making. The downside here is that they are very volatile in nature given their inability to withstand market dislocations or economic downturns. So, basis one’s risk appetite and portfolio requirements, an investor can take a call between investing in various market capitalisations.

Also Read: Problem of plenty for funds as smallcap kitty swells

The constituent stocks of an index can change in future. In view of this, what should investors keep in mind while exposing themselves to Nifty50? Also, for how long should they invest?

An index like the Nifty 50 is rebalanced semi-annually. This is a positive for the investor as there is a continuous check on the index constituents basis certain parameters. Those which do not meet these requirements are changed at the time of review. So, by investing in an index, one can rest assured that certain standards will be maintained at all points in time.

In terms of investment tenure, the key is to invest systematically over long periods of time to enjoy an optimal investment experience. By staying invested over a complete market cycle, we believe an investor can build sizeable wealth over the long term.

According to you, what is the best way to invest a part of one’s portfolio in Nifty50 stocks?

To gain exposure to the Nifty 50 universe, one can consider a Nifty 50-based index fund, ETF or a Nifty 50 Equal Weight Index-based offering. If the offering is index based, one can automate investment through SIP. On the other hand, if it is ETF based, then one will need a Demat account for buying, holding and selling ETF units. To decide on the suitability aspect, do check which of the offering aligns well with your portfolio and investor personality and accordingly make a decision.

What is the difference between a Free Float market cap and Equal Weight Market Cap?

The core area of differentiation between these two strategies is the way in which weights are assigned to each of the stocks in the Nifty50 universe. In an equal-weight index, there is a 2% cap assigned to each of the index constituents. But when it comes to free float, a company with a higher free float is given higher weightage. Given this approach, the top five sectors in an equal weight index tend to be less concentrated thereby providing better diversification opportunities.

Another point of difference is that an equal weight index is re-balanced on a quarterly basis where weights are rebalanced back to equal. This means even if any stock rallies heavily during the period, its weightage would be restricted to the original equal-weight index levels.

Also Read: Small Cap Funds get maximum allocation, trailed by Value, Mid Cap schemes – AMFI June 2023 Data

When do you think an equal weight index would perform or lag behind?

During times of a market correction, the downside in an equal weight index is contained due to a 2% weightage cap for each company. As a result, during volatile times and during broad-based market rallies, an equal-weight index tends to perform well. On the other hand, this strategy tends to lag when there is a narrow rally as seen during 2019.

Can you share a few examples in the recent past when the Free Float-based Index has performed and when the Equal Weight Index has performed?

In the calendar year 2019, when a few index heavyweights were leading the market rally, the free float-based index such as the Nifty 50 TRI delivered a return of 13.5% while the Nifty50 Equal Weight TRI return was at 4.3%. However, in the years 2020, 2021 and 2022 when the indices recovered from the pandemic blues on the back of a broad market rally, the equal weight index outperformed the Nifty 50 TRI by 3.2%, 9.4% and 2.4%, respectively.

Disclaimer: The views expressed in this Q&A are those of the respective commentators. The facts and opinions expressed here do not reflect the views of financialexpress.com. Mutual Fund investments are subject to market risks. Please consult your financial advisor before investing.



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