Is Large Cap Funds losing ground to Index Funds?

Large-cap dedicated funds remains the main stream of the Indian equity mutual fund. At the end of November 2019, almost 20 per cent of the total Asset under Management (AUM) of the equity dedicated mutual fund comes from large-cap category. If we include the multi cap funds, the total share may go beyond 40 per cent or two-fifth of the total AUM. Out of all the 50 odd multi-cap funds that we analysed, the average holding of these funds in large-cap stock is 70 per cent and schemes like HDFC Equity has 90 per cent of their corpus parked in large-cap stocks.

Under such a circumstance, it becomes important for the large-cap funds to keep on performing so that the faith of mutual fund investor remains strong in mutual fund investment. Nevertheless, if we look at the performance of the large-cap funds, it is not very encouraging when compared to their counterpart, index funds. In the year 2018, out of 15 large-cap mutual funds, 14 top performing were passively managed funds including ETFs and index funds. Even in the year 2019, 10 out of the top 15 large-cap schemes in terms of performance, were passively-managed schemes.

The above table shows the trailing annualised returns of large-cap dedicated funds and large-cap dedicated index funds. We can clearly see that in the last three years, period Index funds have outperformed actively-managed index funds. One of the reasons why index fund tend to outperform actively-managed funds is because of the expense ratio. An active fund generally charges one or two per cent fees to manage funds, while the passive scheme charges fee as low as 0.10 per cent. Therefore, for an active fund to beat the passive funds, they need to generate alpha over and above this two per cent, which looks difficult in such an efficient market. Moreover, the re-categorisation exercise carried out by SEBI last year further curtailed their ability to create alpha for their investors.

Three year data is not sufficient to reach at any definitive conclusion, however, investor can see this as a trend and can look seriously to include index funds as part of their portfolio.