Largecap funds: Invest for fair valuations, ability to stabilise portfolio

The market cap of largecap stocks (the top 50 or top 10) vis-à-vis the total market cap is at its lowest level ever, according to the December edition of the DSP Netra report.

 

While mid- and smallcap funds have outperformed, experts recommend maintaining a substantial allocation to largecap funds.

 

“As we navigate uncertain waters, a conservative approach to largecap investing could provide a strategic advantage,” says Sahil Kapoor, head of products and market strategist, DSP Mutual Fund.

 

Stability amid market volatility

 

Largecap funds offer stability in volatile markets. A study on December 12, 2024, by Upwisery of 4,524 stocks listed on the National Stock Exchange found that 53.4 per cent had corrected more than 30 per cent from their 52-week highs. In contrast, only 13 per cent of largecaps had fallen by the same margin. “This highlights the relative stability of largecap stocks during corrections,” says Prashant Joshi, co-founder and partner, head of family office and private wealth, Upwisery.

 

 

Largecaps’ market cap to GDP ratio and profit share to GDP have broadly tracked each other. “Valuations for this category are in line with long-period averages, while other cohorts have seen disproportionate growth in market cap relative to earnings,” says Gaurav Misra, head of equity, Mirae Asset Investment Managers (India).

 

While India’s macroeconomic indicators are strong, equity valuations remain elevated. This could result in bouts of volatility. “Amid the current market dynamics, we are more comfortable with the largecap space due to its relative stability,” says Anish Tawakley, co-chief investment officer–equity at ICICI Prudential Asset Management Company (AMC). He warns about overvaluation in the small- and midcap space, where companies with weak business models are being valued as gems.

 

Misra adds that key sectors like banking, led by larger private and public sector banks, are concentrated in the large-cap category. These sectors have underperformed recently and could do well over the medium term, he says. 

 

Challenges for largecap funds

 

Largecap funds are more sensitive to macroeconomic factors like interest rates, geopolitical events, and economic slowdowns, which tend to impact their performance.

 

Joshi says that largecap funds often operate in mature markets, which limits their potential to offer exceptional growth. Moreover, during market recoveries, they tend to lag behind mid- and smallcaps.

 

“The relative stability of largecap stocks during market downturns often comes at the cost of limited upside potential during recovery phases, making it difficult for these funds to outperform,” adds Joshi.

 

Largecap stocks are also disproportionately affected when foreign institutional investors (FIIs) withdraw funds from India.

 

Active versus passive investing

 

Multiple S&P Indices versus Active Funds (SPIVA) India reports have shown that active largecap funds often struggle to outperform their benchmarks.

 

“The latest SPIVA India report shows that for five years ended June 2024, only 13 per cent of largecap funds could beat the index. This corresponds to the period after the Securities and Exchange Board of India (Sebi) clearly defined largecap and other categories and hence there is clean data available,” says Avinash Luthria, Sebi-registered investment adviser and founder, Fiduciaries.

 

Financial advisers increasingly favour index funds and exchange-traded funds (ETFs) for large-cap exposure.

 

Finally, new and conservative investors seeking stability should have a higher exposure to largecap funds. Seasoned investors may go for a balanced exposure across market caps. Misra suggests staying invested in these funds for the long term to maximise the benefit of compounding.