It’s time invest in large cap funds & move away from mid & small cap funds

The market rally in the last few days suggests that the time has come for mutual fund investors in India to start making a tactical switch from mid and small-cap funds to large-cap and index oriented schemes. Many experts believe that Dalal Street is now ripe for the next cycle of stock rotation, which will mostly benefit large cap stocks unlike the rally in the previous 15 months.

The BSE Mid-Cap index has more than doubled since the end of March last year from 10,570 to close at 23,130 on Wednesday (August 4, 2021).

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The small-cap index has done even better as it almost tripled during the period, rising from 9,608 on March 31, 2020 to close at 26,848 on Wednesday.  In comparison, the benchmark and large cap heavy BSE Sensex is up just 85 per cent during the period. 

The performance gap between the three indices is even starker in the first seven months of the current calendar year. The BSE Small Index is up 48 percent since January 2021 against a 14 percent rally in the Sensex while the mid-cap index is up 29 percent in the period.

This is fully reflected in the performance of equity mutual funds. The small and mid-cap funds have out-performed the large cap and index funds by a big margin in the last 12 months. 

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For example, the top performing diversified equity fund Quant Small Cap Fund is up 147 percent in the last one-year. And the list of top-10 performing equity mutual funds in one-year is fully dominated by the small and mid-cap funds. These top-10 funds have delivered 101 percent to 147 percent returns in the one-year period, nearly 1500 basis points higher than the Sensex returns in the period. One basis point is one-hundredth of a percent.

In comparison, the top performing large-cap oriented fund Canara Robeco Emerging Equities Fund is up just 64.5 percent in the last one year and is ranked 67^th in terms of one-year performance, according to data from ICRA Analytics Mutual Fund India database.

The market moves in the last few days, however, suggest that large cap stocks are making a comeback after lying low for months.

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In contrast, the BSE Mid-cap and Small cap index has been flat since Monday, which is very unusual given their performance so far.

This is one of the sharpest moves by the index in many months after a lacklustre performance in May, June and July this year. In those three months, the Sensex was up just 7.8 percent against a 14 percent and 24 percent rally in the mid-cap and small cap index respectively. The index has now broken through the resistance line and made fresh life-time highs for the second consecutive day which suggests more upside in the coming weeks.

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Many analysts expect the trend to continue as there is no perceptible difference in the performance of large-cap stocks vis-à-vis mid and small caps stocks in the longer-term.

For example, in the last 5-years, BSE Sensex is up 91 per cent from around Rs 28,000 in August 2016 to around 54,400 currently. In the same period, the Mid-cap index is up 75 percent while the small-cap index is up 112 percent. So large cap stocks have done better than mid-caps in the last five-years and Sensex was ahead of the small-cap index till April this year on the base of August 2016. Large cap stocks also tend to out-perform in market volatility and are thus a better store of wealth than mid and small caps.

This will favour the large-cap oriented diversified equity funds. Another winner could be the index funds that track the Sensex, Nifty 50 or Nifty100 index.  The best investment strategy would be to pick good quality large cap funds that have underperformed the broader market by a big margin in the last one-year.

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For example, SBI Bluechip Fund –one of the biggest equity schemes in the country with assets under management (AUM) of nearly Rs 29,000 crore currently –is up just 54 per cent in the last 12-months while Axis Bluechip Fund another big fund with AUM of nearly Rs 28,000 crore, is up only 45 percent in the period.

Another top performer historically, HDFC Top 100 Fund has given just 52 percent returns in one-year. The fund remains among the ten biggest in the country with an AUM of around Rs 20,000 crore.

Another top performer in the past, the Mirae Asset Large Cap Fund is up just 50.3 percent in one-year. The fund ranks among the five-biggest in the industry with an AUM of around Rs 27,000 crore currently.

Another large cap fund, Aditya Birla Sun Life Frontline Equity Fund has underperformed with 54 percent returns in the last 12-months. The fund is among the ten biggest equity schemes with an AUM of nearly Rs 21,000 crore.

It’s time mutual funds start looking at these funds more favourably.

Happy investing!

(Advice: This article is for information purpose only. Readers are advised to consult a certified financial advisor before making investment in any of the funds or securities mentioned above.)

(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).

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