Investing In Large And Mid-Cap Funds: Checks And Balances
In terms of performance, in the last one year multi-cap funds have performed better than the large and mid cap category due to higher allocation towards large-cap stocks
It is pure irony that some categories of funds came into existence only after the market regulator decided to take the initiative to streamline and limit the number of mutual fund offerings by the fund houses. One such category is the ‘Large and Mid-Cap Fund’. Prior to the Securities and Exchange Board of India’s (SEBI) circular on categorisation and rationalisation of the schemes, this category did not exist in its present avatar. According to the SEBI’s re-categorisation, a Large and Mid-Cap Fund is one that invests minimum 35% each in large and mid-cap stocks. The large-cap stock universe consists of the first 100 companies in terms of market capitalisation, mid-caps consists of 101st – 250th and small-caps 251st company onwards. Therefore, for the large and mid-cap category, 70% of the portfolio is constituted by the first 250 stocks. The rest 30% can be invested into any category of stocks.
Why Large and Mid-Cap Fund?
The primary idea behind the creation of such a category is that it will give investors best of both worlds – better returns with lower downside. The large-cap component of these funds helps restrict the downside risk. This is visible in the current situation where large-cap-dedicated equity indices have performed better than the broader market. The broader market like mid-cap and small-cap are struggling and have been wallowing in the negative territory over the past one year compared to frontline indices like Sensex, which has generated positive return in the last 12 months. Nevertheless, in year 2017, it was a reverse situation since the broader market was touching new highs while the performance of the large-cap stocks and their indices were lagging behind.
We see that the idea of this category of fund looks good as its performance lies between large-cap and mid-cap categories. In terms of return, it is better than the mid-cap fund but worse than the large-cap category. This is true for the last one year as overall the mood of the market is not great and is negatively tilted. It is expected that once the market regains its momentum due to the corporate tax rate cut, the large and mid-cap categories of funds are going to perform better than the large-cap due to higher beta as compared to large-cap funds. Therefore, this category of fund helps an investor to have a smoother investment experience.
However, if we look at the funds from this category, all the funds except a couple of them existed before the categorisation. Only two funds have been launched in this category in the last 18 months. Most of them were earlier classified in the equitydiversified category and some were even from large-cap funds. There were only a couple of funds that were large and mid-cap funds such as Quant Large and Mid-Cap Fund and LIC MF Large and Mid-Cap Fund. The following table shows how large and mid-cap category funds were before SEBI’s categorisation of scheme kicked in.
Hence, it may seem that this category has been created only to accommodate the existing funds that could not be adjusted in any other category or because fitting them in any category would have resulted in large churning in the portfolio. This is especially true when there is already a multi-cap category whose look and feel is very much like the Large and Mid-Cap Fund.
Large and mid-cap funds versus multi-cap funds
It is clear that the Large and Mid-Cap Funds is different from large-cap and mid-cap funds both in terms of return and risk. Nonetheless, there is an uncanny resemblance between multi-cap funds. The regulator defines multi-cap fund as those funds that need to have a minimum investment in equity and equity-related instruments of 65%. Multi-cap schemes are allowed to invest in any mix of large, mid and small-cap stocks that the fund manager deems appropriate, as long as at least 65% of the monies are in equities.
Take a look at the portfolios of some large and mid-cap funds and multi-cap funds. There does not seem to be much difference in terms of make and design of the portfolio constituents. Both are large-cap dominated with lower allocation towards small-cap stocks.
In terms of performance, in the last one year multi-cap funds have performed better than the large and mid-cap category due to higher allocation towards large-cap stocks.
Choosing the better option
Though, on the surface, there seems to be not much of difference between these categories of funds, there is some difference beneath. In case of large and mid-cap category there is less flexibility in the hands of a fund manager to the extent of exposure to different market cap stocks. In any case, he has to maintain 35% of the exposure to large-cap stocks and mid-cap stocks to the same extent.
In case of multi-cap funds, the fund manager can change the shape and size of the fund according to his prognosis of the market. If he believes that going ahead, the markets are likely to grow at a higher pace, he may allocate more funds towards mid-cap and small-cap stocks to average better gains.
In case of large and mid-cap, he cannot exceed 65% in mid-cap stocks as he has to invest at least 35% in mid-cap stocks. Therefore, investors who want their fund manager to take a call on the market and rely on his decision can invest in multi-cap funds. However, for those investors who wish to provide that flexibility, but only to a limited extent, the large and mid-cap category works better for them.
