X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2018 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Are you blindly holding Large Cap Funds? - Outside View by PersonalFN

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Are you blindly holding Large Cap Funds?
Jan 28, 2012

On January 08, 2008 BSE Sensex surpassed the21,000 markfor the first time in the history of Indian capital marketsthereby hitting a new high.However, the joy was ephemeral,as by the end of the month the BSE Sensex tumbledto sub 18,000 levels. January 2008 saw the end of multi-year bull run which depicted a strong impulse since early 2006 in the Indian equity markets. Party ended on D-street and gloom superseded the boom. Since then the BSE Sensex has failed to breach the previous high, and the tussle between the bears and bulls still continues. We are most likely to end January 2012 at a level lower than where we ended in January 2008 on BSE Sensex.Other major indices too are likely to follow the suit. This may get you thinking how long is long enough to benefit from equity investments if India's 30 most valued companies failed to grow your wealth over last 4 years. It is often said that investment in large cap stocks and large cap mutual funds is safer than that in the mid and small cap stocks/funds. Also, over the longer term midcaps are believed to outperform large caps. In the wake of rapidly changing investment environment it becomes imperative to revisit some conventional tenets such as these to check their effectiveness in the present era.

A Study of Market Capitalisation and sector exposure:

Let's begin with the analysis of market capitalisation.Since S&P CNX Nifty is the most widely tracked index (even than the BSE Sensex); it is important to find outthe representation it gets in the market cap. As per the data published by NSE on December 30, 2011, Nifty stocks constitute about 66.9% of the market capitalisation of all the stocks listed on NSE. CNX 100 accounts for around 79% of the market capitalisation. BSE 200, which is an even broader index; represents about 84% of the market capitalisation. Midcaps and small capson the other hand get the lesser representation in the entire market capitalisation although they are more in number.

But as you know market capitalisation constantly undergoes a change albeit at a very slow pace. In the year 2000, the market capitalisation took a bizarre shape as top-50 stocks on NSE accounted for more than 75% of the total market capitalisation.Since then composition of top-50 stocks in the market cap has fallen considerably. On the other hand, smaller companies have gained the ground.The number of stocks listed on NSE has more than doubled over last 12 years. We have seen significant rise in the market capitalisation. For example, market capitalisation of the 50th stock today is several times more than that of the 50th stock as in the year 2000. This is because the participation of investors especially institutional ones, is far greater than what we witnessed 10-12 years ago. Thanks to numerous new listings for this that we have witnessed in the last decade.

Sector wise exposure of some major Industries to respective market capitalisations
Sector S&P CNX Nifty CNX Midcap CNX Small Cap
Banks 17.4 13.3 6.9
Energy 17.4 10.6 9.4
IT 15.8 3.3 8.3
Consumer staples 7.7 13.9 7.4
Engineering 5.5 9.6 9.4
Pharmaceuticals 4.3 9.8 1.1
Chemicals - 4.4 11.6
Note1: The indices for market capitalisation are of that of NSE, while for sector categorisation classification of AMFI is followed and in that
process we have clubbed some sectors such as oil, gas, power, etc. under energy to make the allocation more meaningful.
Note2: The indices for market capitalisation have been used only on a indicative basis, and therefore aren't exhaustive
(Source: NSE, PersonalFN Research)

As seen from the above table, although all major indices on Indian bourses are fairly diversified, some sectors dominate the overall sectorial allocation in every index.Beyond any shade of doubt, the banking sector holds a dominatingshare in allmarket capitalisations. Also, interestingly as we go down the market capitalisation hierarchy, dominance of sectors such as engineering and chemicals has elevated in the mid and small cap segment. This reveals that as you move across market capitalisation hierarchy your risk is closely linked to the fortune of those dominant sectors as well.

Hence while you invest your hard earned money in these respective market capitalisations, it is imperative to assess on which sectors they are betting on.

Base: Rs 100
Note: CNX Mid cap index and CNX Small cap index have not been depicted in the chart above,
as their data was unavailable as on April 1, 2003 due to they being incepted at a later date
(Source: NSE,BSE, PersonalFN Research)

So far the table above reveals that among the indices representing the market capitalisations, the small and mid cap ones' have outperformed the large caps and also the predominant large caps ones'.

No. of times wealth generatedfor the level of risk taken
Index Std. Dev Multiplied wealth by (No. of times)
S&P CNX Nifty 8.25 5.1
CNX 100 8.44 5.4
BSE-200 8.74 5.6
BSE Midcap 10.24 6.3
BSE Smallcap 12.03 7.5
(Source: NSE,BSE,ACE MF,PersonalFN Research)

Thus as depicted by the table above, by assuming a certain amount of risk (as revealed by the Standard Deviation) the respective indices have been able to multiply wealth at respective times. Moreover, the risk levels also reveal the trait of respective indices. For instance the CNX small cap index has exposed to a greater amount of risk thus exhibiting their trait of being highly risk, as compared to mid and large cap ones'.

However a noteworthy point is that, there is not much a difference in the performance of top-50 companies and the top-200 companies (market cap wise). So in that context, have large cap funds helped in building wealth?

Performance of Large Cap Funds

As you may be aware that actively managed mutual funds enable you to diversify your investment across market capitalisation and sectors. And in their attempt to do so, they usually benchmark their performance against a suitableindex, which it follows closely and aims to outperform.

We had a look at the performance of various mutual fund categories to figure out if the large cap funds have followed the large cap diversified indices, and whether they have really outperformed.We used the BSE-200 index to gauge the performance of large cap funds both the pure cap large cap funds as well as the predominant large cap funds.

How the Various Categories of Mutual Fund Schemes Fared?
Category Average 1 Year 3 Years 5 Years 7 Years 10 Years Std. Dev
Large Cap Funds -11.1% 23.0% 5.1% 16.7% 23.3% 8.2%
Mid Cap Funds -13.1% 29.6% 2.8% 15.5% 24.0% 9.8%
MultiCap, Flexicap and Opportunities Funds -12.6% 25.3% 4.9% 16.8% 22.8% 8.7%
Indices
BSE-100 -12.4% 24.4% 3.8% 14.7% 18.4% 9.3%
BSE-200 -13.8% 24.6% 3.6% 13.9% 19.1% 9.5%
CNX Midcap -17.2% 26.4% 5.2% 13.9% 23.1% 10.2%
S&P CNX 500 -13.9% 23.4% 3.0% 13.1% 18.5% 9.4%
Note: Category average reflects those funds which have been in existence for 3 years, and thus is the simple average of 30
large cap funds, 28 midcap funds and 42 multicap, flexicap and opportunities funds.
NAV data is as on January 20, 2012
(Source: ACE MF, PersonalFN Research)

And the table above revealed that the large cap funds (including predominant and pure large cap ones) have faded over 3 years, 5 year 7 years and 10 years' time frames, when compared to average returns of various categories of mutual funds based on capitalisation and styles followed. Moreover, the average risk which they have assumed to provide such returns is not exceptionally low either.

Performance of Various Categories of Mutual Funds across Market Phases
  Bull Phase Bear Phase Bull Phase Corrective Phase
Category Average 01/Aug/05 To 09/Jan/08 09/Jan/08 To 09/Mar/09 09/Mar/09 To 05/Nov/10 05/Nov/10 To 20/Jan/12
Large Caps 54.00% -53.00% 74.30% -16.90%
Mid Cap Funds 50.00% -63.90% 103.60% -21.10%
MultiCap, Flexicap and Opportunities Funds 53.00% -56.30% 84.20% -18.50%
Indices        
S&P CNX Nifty 50.30% -53.50% 71.70% -16.90%
BSE-100 52.50% -58.10% 81.00% -18.50%
BSE-200 51.60% -59.00% 84.40% -20.00%
Note: Category average reflects those funds which have been in existence for 3 years, and thus is the simple average of 30
large cap funds, 28 mid cap funds and 42 multi cap, flexi cap and opportunities funds.
NAV data as on January 20, 2012
(Source: ACE MF, PersonalFN Research)

But a noteworthy point is that during bear and corrective phases of the Indian equity markets, they have shown a tendency to arrest the downside much better, as compared to mid cap funds as well as multi cap, flexi cap and opportunities style funds. Also when compared to broader indices they have fallen lesser. This in return reveals the defensive trait of large cap funds in times when equity markets experience turbulence. During bull phases of the Indian equity markets too, the large cap funds have been successful in creating "alpha" returns, as the returns clocked by them have outperformed those clocked by the broader indices.

Outperformance of the Top performer over the bottom performer
  Bull Phase Bear Phase Bull Phase Corrective Phase
Return Differential 01/Aug/05 To 09/Jan/08 09/Jan/08 To 09/Mar/09 09/Mar/09 To 05/Nov/10 05/Nov/10 To 20/Jan/12
Large Cap Funds 20.3% 19.2% 43.6% 13.7%
Midcap Funds 24.8% 21.1% 52.9% 32.0%
Multi, Flexi, Opportunities Funds 30.8% 21.0% 50.0% 20.8%
(Note: we have only considered those funds that have completed minimum 3 years since our aim is to find out their performance in the long term.)
(Source: ACE MF, PersonalFN Research)
But you can't go by the defensive trait always and invest in a large cap fund blindly. So we compared large cap funds, mid cap funds along with those following multi, flexi and opportunities style and gauged that there is huge difference in return in top performer and the bottom performer. Difference between the return generated by the top performer and the bottom performer during each market phase showcased above brings forth some startling facts. Despite having similar investment mandates and comparatively limited stock universe, returns generated by two large cap funds have been be as different as chalk and cheese. The difference only widens in case of other two categories. To make things even more complicated, not all schemes have shown consistent trend in their performance.

Final Verdict

While large caps attract the more money because of their stable businesses, greater market share, quality of management and the sustainability prospects; it is imperative for you to do enough research in investing in large caps as well, and not blindly invest in them.

Sure, global offshore funds focusing on India too may prefer larger companies over the smaller ones since the larger companies are more researched and hence more dependable. Domestic institutional investors too cannot undermine large caps because of their dominance in the market capitalisation structure. But these cannot be tenets for you to invest blindly in invest in large cap funds.

We think that large cap funds are the indispensible part of any equity portfolio irrespective of the risk appetite of equity investor.So even if you have a large appetite for risk, you must position your portfolio which some petite composition of large cap funds (along with mid and small cap funds showing a dominant portion). On the other hand if your appetite for risk taking isn't very high, but you want to invest in equity funds; then large cap funds along with some good balanced funds whose equity portfolio is skewed towards large caps can do well to your portfolio.

Needless to say, you should be extremely cautious while selecting a mutual fund; as funds in the same category vary significantly from one another in terms of performance. Moreover, relying on star ratings may not always do good to your portfolio.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Equitymaster requests your view! Post a comment on "Are you blindly holding Large Cap Funds?". Click here!

  

More Views on News

Sorry! There are no related views on news for this company/sector.

Most Popular

How to Avoid a 90% Loss Suffered by This Super Investor(The 5 Minute Wrapup)

Jul 12, 2018

Blindly following super investors is a dangerous game to play. Here's how you can avoid such mistakes.

The Answer to Your Wealth Worries: Small Caps (Especially Now)(Profit Hunter)

Jul 10, 2018

If you're worried about the markets - you are on the wrong track. This is opportunity - put your wealth-building hat on, instead - Richa shows you how...

The Multiple Problems with the Minimum Support Price (MSP) System(Vivek Kaul's Diary)

Jul 11, 2018

The price signals that MSP sends out, creates its own set of problems.

New Fund Offer - ICICI Prudential Pharma Healthcare and Diagnostics Fund - Should You Invest?(Outside View)

Jul 6, 2018

ICICI AMC launches an open -ended equity fund following Pharma, Healthcare, Diagnostic and allied theme.

When Disappointment Panda is Around. Buy Quality Stock like This!(Chart Of The Day)

Jul 6, 2018

Buy Companies that can fight all kinds of Pandas and Bears in the long run.

More

Small Investments
BIG Returns

Zero To Millions Guide 2018
Get our special report, Zero To Millions
(2018 Edition) Now!
We will never sell or rent your email id.
Please read our Terms

MARKET STATS