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Bigger is better when it comes to Mutual Funds

Bigger is better when it comes to Mutual Funds

Why does one invest in Mutual Funds? It enables you to invest in diversified portfolio of stocks and thus protect your portfolio from ups and downs in the markets. Large-cap mutual funds stand true to this definition. These funds generally invest large amount of their asset under management (AUM) in some of the biggest companies, which represent one of the components of benchmark indices such as the 30-share BSE Index or the 50-share Nifty.

 In terms of size, mutual funds can be divided into 4 broad categories: Large-cap, Mid-Cap, Small-Cap and Multi-Cap funds.

Why large cap funds?

Large cap funds are considered safe and stable. They are less volatile compared to other diversified equity funds even to the market swings and they mirror the performance of the economy. Unlike mid-cap or small-cap stocks, which tend to give super-normal returns during rising market as compared to large cap funds, they don’t have the resilience to weather bad market conditions. Hence they tend to rise sharply during the bull-run and nosedive when the markets turn bearish. Large-caps funds, which invest in good quality stocks, have the size and scale to weather the bad market phase.

For instance, in the bear market periods in 2008 and again in 2011, large-cap funds outperformed mid-cap funds. This is despite the fact, that midcap funds outperformed large cap funds in most bull market years over the 2006 to 2011 period.

In short, the possibility of capital erosion is far lower in large-cap funds as compared to mid-cap or small-cap funds. Such funds are a safe bet for investors who look for long-term capital appreciation by taking relatively lower risk.

Largecap funds vs. Midcap funds

As mentioned above, large cap funds may not deliver exceptional returns in a rising market. Because of the sheer scale and size of stocks in this category, the growth is not as high when markets bounce back as it would be for mid- and small-cap stocks.

However, if you put all your hard eared money in mid-cap funds or small-cap funds you need to know that there are limited good quality mid-cap stocks. So, if the size of fund becomes very large, the fund manager may end up buying high proportions of the same high quality stock. Alternately, the fund manager may also invest a part of the portfolio in low quality mid-cap stocks. Either of the propositions carry high risk for you as an investor.

Ideally almost 70% of your mutual fund portfolio should comprise large cap diversified equity funds. The balance can invested in a basket of mid-cap and multi-cap funds.

Stay invested to get maximum benefits

As per the Value Research data, ICICI Prudential Focused Bluechip fund, which was launched in 2008, has given an annual return of 14.39%. Birla Sun Life Frontline Equity Fund has grown at Compounding Annual Growth (CAGR) of 22.68% in the past 14 years. On the other hand, if you look at average inflation (consumer price index) has touched the highest of 10.92% in 2013. This clearly shows that large-cap funds are not just less risky but also beat inflation, if you stay invested for a long time.

About the Author

Pankaj Mathpal

Pankaj Mathpal, Founder and Managing Director, Optima Money Managers Pvt. Ltd. has over 22 years of work experience in Marketing, Financial Planning & Education. Read More…