What are large cap funds?
Large cap funds typically invest in large sized companies, the bluechips, so to say. Typically, these companies form a part of the Sensex 30 index or the Nifty 50 index.
Within mutual funds, you get two types of fund management – active and passive.
When you choose an active fund, a fund manager along with his/her research team decides which stocks to invest in and how much. The portfolio design and management is ‘active‘ based on their assumptions, understanding of business and the funds available.
Passive funds are by nature passive. All they do is select an index and invest exactly as per the index. For example, if there are 30 stocks in the Sensex, each with a unique weightage, the passive fund will mimic this as it is. As you would guess, there is no need of a fund manager or research team in case of a passive fund – thus saving some money on expenses. Passive funds are also called Index Funds.
For more details on active vs passive, you can look at this primer.
Coming back to large cap funds, when you choose an active large cap fund, you believe that the fund manager talk that s/he can constructing a better portfolio than the index itself and hence generate a higher return for you. For this effort, s/he charges you an additional expense too.
For a long time, fund managers of large cap funds could indeed generate a better return with their skill and beat the index returns by a significant margin.
However, this argument is coming apart now.
Look at the image below for a peer comparison of large cap funds along with Sensex and the category.
Source: Unovest. Data for regular plans of the above mutual funds. Do add about 1.5% to 2% of dividends to the S&P BSE Sensex to arrive at its Total Return and make a fair comparison.
As you will notice, the performance of the large cap funds is constantly falling behind their index. In other words, it is becoming difficult for the actively managed funds to beat the index.
One simple reason is that the nature of market is changing and there is lot more investor interest.
If you look at the facts, there is more investor money coming into the markets, specially via the equity portion of National Pension Scheme and the Employees Provident Fund. This investment runs into thousands of crores every year. Take for instance EPFO, which is planning to invest Rs. 22,500 crores in this financial year 2017-18 (source).
Both the organisations go with index funds – ETF or Exchange Traded Funds based on Nifty 50 and Sensex 30 index – which invest in bluechips of the bluechips.
Interestingly, while the constant money supply ensures that the large cap stocks keep growing, it leaves little scope for the actively managed large cap fund to have ‘special insights‘ to outperform. Even if they have, the liquidity driven stocks will leave them no space to benefit from that insight.
See the image below for a peer comparison of index funds along with Nifty 50 and the category.
Source: Unovest. Only regular plans considered.
As you can see, the index funds move closely with the index.
For now, I can say that that investors who want to take exposure to pure bluechip stocks can simply avoid the active funds and go for the index variants. At least, you save the extra costs and still generate similar or more returns.
But the fund managers are not going to leave you so soon. They are very smart.
You see this smartness at work when they pitch to you not a large cap fund but a “predominantly large cap” fund, with large cap as not the only focus.
Aditya Birla SunLife Frontline Equity Fund, a popular predominantly large cap fund, says this for itself:
A diversified equity fund that invests across sectors in line with S&P BSE 200 Index, with a bias for large caps but not exclusively focused on them.
Even its portfolio allocation confirms this statement. And by doing this, it now pushes itself into another category – multi cap.
See this image below for peer comparison along with benchmark and category for the fund.
Source: Unovest. Don’t forget to add 1.5% to 2% for dividend to the index return to make a fair comparison.
Several other large cap funds do the same thing.
As this phenomena grows, you will witness large cap funds turning themselves moving beyond large cap category. That is the only way they will be able to generate ‘alpha’ or the elusive additional return to be able to justify their fund management expenses.
Similarly, there are other variants such as the “Large Cap Advantage”. Even with index funds, you can see “sensex plus” or “nifty plus”.
There is deliberate anxiety of choice kept for you.
My two words of advice – Watch out!