Choosing the right equity mutual fund scheme can be a daunting task. The key factors to consider include stock selection, the skill of fund managers, and the historical performance of the scheme. However, when building an equity portfolio, market capitalization is a crucial parameter that influences both the risks and potential rewards. Equity mutual fund schemes are categorized based on market capitalization, with large-cap mutual funds being one such category.
Let’s explore the world of large-cap mutual funds and learn about the key features of these investment avenues.
Defining the term Large-cap
Market capitalisation, or market cap, signifies a company’s total valuation, which aids in classifying stocks into large-cap, mid-cap, or small-cap categories. The market cap is computed by multiplying the company’s market price by the total number of outstanding shares. For instance, let’s take Coal India Ltd. as an example. If its market price is Rs. 240 and it has Rs 620 crore shares, the market cap of Coal India Ltd. is calculated as 620 crore shares x Share price Rs 240 = Rs 148,800 crore.
As per SEBI norms, the top 100 companies in terms of market capitalization qualify as large-cap stocks. The subsequent 150 companies, ranking from 101st to 250th in terms of market cap, fall under the mid-cap category, while those beyond the 250th position is categorized as small-cap stocks. With this classification, one can deduce that Coal India Ltd. belongs to the top 100 companies bracket, designating it as a large-cap company.
Large Cap vs. Mid Cap vs. Small Cap: Understanding the Hierarchy
- Large-Cap Funds
Large-cap funds primarily invest in the equity of large-cap stocks listed on the exchange. SEBI’s guidelines dictate that a large-cap fund must invest a minimum of 80% of the funds in large-cap companies, translating to 80% of your investment flowing into the top 100 companies by market capitalization. The remaining 20% can be allocated to mid or small-cap stocks. These large-cap companies, renowned for their reputation and market dominance, provide stability, steady growth, and fewer fluctuations.
- Mid-Cap Funds
Mid-cap funds commit a minimum of 65% of their assets to equity and equity-related instruments of mid-cap companies, adhering to SEBI’s regulations. While mid-cap stocks entail higher risks than their large-cap counterparts, they offer greater growth potential compared to large-cap stocks and exhibit less volatility than small-cap stocks.
- Small Cap Funds
Small-cap funds allocate at least 65% of their assets to small-cap companies characterized by their high growth potential, often reflecting youthful businesses with ambitions for aggressive expansion. On the downside, small caps tend to be more volatile than mid and large-cap counterparts, occasionally experiencing sharp negative returns during market turbulence. In comparison to large-cap funds, mid and small-cap funds provide a wider universe of stocks to invest in, but this broader pool can come with reduced liquidity.
key features of large-cap funds to keep in mind before investing:
- Risk and Return: All equity mutual funds are subject to market fluctuations. When the benchmark of a fund fluctuates, the Net Asset Value (NAV) mirrors these movements. However, unlike small-cap and mid-cap schemes, large-cap funds tend to exhibit more stability in their NAV. Hence, investing in large-cap schemes can impart reassuring stability to your investment portfolio. It is important to remember that returns from large-cap funds typically fall short of those from mid-cap or small-cap funds. As such, large-cap funds are best suited for investors seeking dependable returns with a lower degree of risk exposure.
- Expense Ratio: The expense ratio is the fee charged by fund houses for managing your investments. It is a percentage of the fund’s total assets, used for administrative and other fund management functions. SEBI has mandated that fund houses cannot charge an expense ratio exceeding 2.50%. Given that large-cap funds, in general, generate more modest returns compared to mid-cap or small-cap schemes, selecting a fund with a lower expense ratio can help optimize your returns.
- Investment Horizon: Large-cap funds may undergo temporary underperformance during market downturns. However, the presence of investments in financially robust companies allows this underperformance to smooth out over time. The rule of thumb here is that if you maintain your investment for more than seven years, you can anticipate returns in the range of 10-12%. Therefore, large-cap mutual funds are primarily recommended for investors with a long-term investment horizon.
- Tailoring Your Investment to Your Financial Goals: Large-cap mutual funds exhibit a fair degree of risk and offer stable returns. This makes them an attractive choice for investors considering retirement planning. Additionally, investors eager to enter the equity markets without taking on excessive risk often find a comfortable entry point in large-cap mutual funds. It is imperative to align your financial objectives with your investment decisions.
As equity funds, large-cap mutual funds are subject to both capital gains tax and dividend distribution tax.
- Dividend Distribution Tax (DDT): Fund houses are required to deduct a DDT of 10% at the source before disbursing dividends.
- Capital Gains Tax: Upon redeeming units of a large-cap fund, you will realize capital gains, which are subject to taxation. The tax rate depends on the holding period, or the duration for which your investment was held.
- Short-Term Capital Gain (STCG): For holding periods of up to one year, capital gains are classified as STCG and taxed at 15%.
- Long-Term Capital Gain (LTCG): For holding periods exceeding one year, the capital gains fall under LTCG. LTCG up to Rs. 1 lakh is not taxable. Any LTCG surpassing this threshold is taxed at a rate of 10% without indexation benefits
Large Cap Funds: Returns and Risks
- Exploring Potential Returns:
Now that we have understood the meaning of large-cap funds and the essence of market cap distinctions, let’s delve into the returns generated by select schemes and assess their performance over different timeframes. The following table displays returns under various fund schemes for you to analyse and gauge how returns fluctuate within the same fund category over different time periods. The 3-year and 5-year periods, being relatively long-term, capture market cyclicality and offer a clearer picture.
- Understanding the Associated Risks:
Though large-cap funds predominantly invest in well-established and reputable companies; they are not entirely devoid of risk. They are, however, less risky compared to mid and small-cap funds. These blue-chip companies are subject to market risk and company-specific risk. Diversification helps mitigate company-specific risk, but market risk, also known as systematic risk, impacts the entire market and is not easily diversified. Large-cap companies are typically industry leaders with strong management teams and robust corporate governance, which provides some cushion against market volatility. Over time, they have shown resilience to market downturns, making them less risky than mid and small-cap investments.
Benefits of investing in Large Cap Funds:
- Risk-Averse Investors: If you prefer earning returns over the medium to long term without exposing yourself to severe market fluctuations, large-cap funds are an ideal choice.
- Portfolio Stability: Allocating a portion of your investments to large-cap funds can help minimize the overall risk in your portfolio, offering stability.
- Novice Investors: If you’re new to the stock markets, the volatility of mid and small-cap funds may be overwhelming. Large-cap funds, positioned as the least risky within the equity fund category, are advisable for novices due to their relatively lower volatility and risk.
- Retirement Planning: Large cap stocks, known for providing slow but steady growth through capital appreciation, can assist in building a corpus to meet your future retirement needs.
- Long-Term Investors: If you have a long-term investment horizon and seek steady returns with lower risk, large-cap funds are a suitable choice.
In summary, large-cap mutual funds are a versatile choice for a range of investors. Offering stability, reduced risk, and dependable returns, they suit diverse financial goals. Whether you’re a novice seeking a secure entry into equity markets, a risk-averse investor prioritizing portfolio stability, or a long-term planner, large-cap funds provide a balanced option.
While they don’t offer the same high-risk, high-reward dynamics as mid and small-cap funds, their steadiness in volatile markets is valuable. To decide on your investment, align your objectives and risk tolerance. Consider large-cap funds and consult a financial advisor for a well-informed choice in your financial journey.
Disclaimer: This blog has been written exclusively for educational purposes. It is based on several secondary sources on the internet and is subject to changes. The mentioned names are not recommendations. Please consult an expert before making related decisions.