Why Higher Allocation to Largecaps Makes Sense in the Current Markets

In 2025, despite the trade war, geopolitical tensions, and macroeconomic uncertainty, the Indian equity market has continued to attract several investors.

Although this year the returns are muted so far compared to the previous two years, the fact is that wealth is being generated.

Foreign Portfolio Investors (FPIs) have been edgy with net sales of Rs 1.54 trillion (tn) worth of Indian equities.

But domestic institutional investors have exuded confidence in the prospects of the Indian economy and equity markets with net buying over Rs 4 tn in the equity markets.

Similarly, individual investors have been net buyers with unwavering confidence.

Midcaps and smallcaps have been the favourites. It is for this reason these stocks have surged, delivering handsome compounded annualised returns of 28.5% and 28.8% in the last 5 years.

However, of late, the returns delivered by midcaps and small have slowed. In 2025, so far, the Nifty Midcap 150 - TRI is up 3.4%, while the Nifty Smallcap 250 - TRI is down 3.4%.

How to Approach the Indian Equity Market Now

The Indian equity market is commanding a premium over the rest of the world.

The Morgan Stanley Capital International (MSCI) India Index trailing PE is currently at 26, higher than the MSCI Emerging Markets Index and MSCI World Index trailing PEs, which are around 16 and 24, respectively.

Even on a 12-month forward PE, the MSCI India Index, with a PE of nearly 22, is higher than the world and emerging markets PEs that are around 20 and 14, respectively.

India's Current Marketcap-to-GDP Ratio

Based on historical values, divided into five zones.
Source: https://www.gurufocus.com/global-market-valuation.php?country=IND; data as of October 13, 2025.

Even when evaluated on India's market capitalisation-to-GDP ratio, famously called the Buffett indicator (named after legendary investor Warren Buffett), it is in the 'significantly overvalued' zone.

If we look at midcaps and smallcaps, they look even more stretched. The midcap index and smallcap index PEs are around 36 each (as of 13 October 2025).

The Small Cap Index-to-Sensex ratio is at 0.6 vis-a-vis the long-term median of 0.4. In 2018, when this ratio was around 0.6, the mid and smallcaps crashed. We could potentially see a repeat of that.

The margin of safety is certainly not comforting in small and midcaps. Hence, don't get carried away by only their past returns.

• "The essence of investment management is the management of risks, not the management of returns."- Benjamin Graham

The largecaps, on the other hand, seem to be offering reasonable safety. The PE of the largecap index is around 23, within the typical average range of 20-25.

Largecaps are the top 100 companies by market capitalisation, have a large economic moat and are run by mostly efficient and ethical managements.

Moreover, many are financially sound, well-established, and are generally market leaders in their respective sectors. For this reason, many largecaps are also referred to as bluechips.

In the current market scenario, there are headwinds from trade wars, geopolitical tensions, capital outflows, currency depreciation, macroeconomic uncertainty and the potential impact on corporate earnings and volatility.

Largecaps potentially offer better stability and can grow your wealth steadily compared to midcaps and smallcaps.

The market data also reveals that in the last couple of months, some smart investors are shifting their portfolio allocation in favour of largecaps.

Follow a Core & Satellite Investment Strategy

We believe largecaps should be a part of your 'Core' equity portfolio. You would potentially benefit from long-term wealth creation with an investment horizon of 3-5 years or more as these companies grow, and the economy expands.

One positive thing is that India has consolidated its position as the world's fastest-growing major economy and is expected to become the third-largest economy with a projected US$ 7.3 tn GDP.

The recent next-gen GST reforms - a 2-tier GST structure of 5% and 18% for most goods & services in effect - are also expected to boost consumption, which contributed around 60% to India's GDP.

Now all this doesn't mean that you should stay away from smallcaps and midcaps completely. Don't be carried away by exuberance but follow a sensible asset allocation to create wealth.

Smallcaps and midcaps can be in the 'satellite' portion of your equity portfolio, provided your personal risk profile is very high and you have an investment horizon of 7-8 years or more.

The core portion with largecap allocation will add stability, while the satellite portion with smallcaps and midcaps can push up the overall returns of the portfolio.

Such a 'Core & Satellite' can prove sensible when deploying money into equities in the endeavour to build wealth.

At a time when valuations look stretched, it may be sensible to make staggered lump sum investments or take the SIP route if you are planning for certain financial goals.

Follow a prudent asset allocation; avoid making ad hoc investments.

Be a thoughtful investor.

Happy investing.

Disclaimer: This article is for information purposes only. It is not a recommendation and should not be treated as such.