For mix of stability and growth, invest in large and midcap funds

Investors overweight on small- and mid-cap funds may consider booking profits there and allocating to these funds

Large and midcap funds are currently in focus due to the introduction of new fund offerings, including an index fund and an equity-linked savings scheme tracking the Nifty LargeMidcap 250 by Zerodha Fund House. 

Amid the post-pandemic market rally, investors have focused on small and midcap stocks and equity funds, largely overlooking the largecap category. The recent bout of volatility has served as a reminder of the risks associated with excessive exposure to small and midcap categories.
 

By booking profits in these smaller categories and reinvesting the funds into large and midcap funds, investors can achieve a better balance between returns and risk.
 

According to Arun Kumar, vice-president and head of research at FundsIndia, “Large and midcap funds offer a balanced exposure to well-established largecap companies and potentially high-growth midcap firms. This diversification can provide a buffer during market volatility. Additionally, these funds can smooth out the return experience across different market cycles.”

Abhishek Gupta, fund manager-equity at Edelweiss Mutual Fund, describes large and midcap funds as all-season products.

“Most conventional evaluation parameters such as relative stability of returns, consistent outperformance compared to the broader market, and diversification benefits are met by investing in large and midcap funds,” he says.

What’s on offer?
 

According to the Securities and Exchange Board of India’s (Sebi’s) categorisation, a large and midcap fund must invest a minimum of 35 per cent each in mid and largecap stocks. The fund manager is free to invest the balance wherever he/she likes.
 

Says Gupta: “Investors enjoy the advantages of both large and midcap funds within a single fund. The 30 per cent allocation, which is at the fund manager’s discretion, can lead to a well-diversified fund structure. Such an approach can generate alpha over time with lesser volatility compared to specific market capitalisation-focused strategies.” Flexicap funds are a close alternative to this category. As of September 30, 2023, they had an allocation of 73 per cent to largecap stocks, 24 per cent to midcap stocks, and the balance to smallcap stocks.
 

The risk-reward matrix
 

These funds are positioned between largecap funds on one side and small and midcap funds on the other on the risk-reward gradient.
 

Investors with a higher risk appetite may opt for pure small and midcap funds that are more prone to higher volatility. Those with a relatively lower risk appetite may want to allocate money to large and midcap funds that offer exposure to relatively less volatile largecaps as well.
 

Remember, however, that these funds are likely to be more volatile than a pure largecap fund. Says Kumar: “During extreme market conditions, large and midcap funds may not be as stable as pure largecap funds.”
 

Active or passive funds?
 

Both active and passive fund options are available in this segment.
 

Vishal Jain, chief executive officer at Zerodha Fund House, explains how to make this choice.
 

“Investors can achieve their objectives using a combination of passive and active strategies through the ‘core’ and ‘satellite’ approach. The core (the main part of the portfolio, which is usually larger) of one’s portfolio should hold a low-cost index fund/exchange-traded fund linked to a broad market index. This would give investors the true market returns without them taking unnecessary risks to outperform. The satellite (smaller part of the portfolio) portion may be used to take additional risk through various active strategies,” he says.
 

Kumar prefers active funds.
 

“Given the flexibility to move across mid and largecap categories and the historical evidence of several active funds outperforming in the midcap space, we would prefer to go with active funds managed by proven fund managers in this category,” he says.
 

Long horizon is a must
 

Invest in this category only if you have a long-term perspective.
 

“Based on daily rolling return analysis, the Nifty LargeMidcap 250 has never witnessed negative returns during the seven-year and ten-year investment horizons. One should have a minimum five-year horizon in these funds,” says Jain. Investors who do not want the hassle of exposure to separate mid and largecap funds (and rebalancing between the two) may opt for this composite category.