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Why do you need large cap funds in your portfolio?

Large-cap companies with high market capitalisation (upwards of Rs 28,000 crore as per AMFI classification) have unique characteristics that differentiate them from the rest.

Many investors are aware of diversifying their investments across different asset classes – equity, debt, and cash equivalents. However, do they take it further; by spreading their equity investments across the market capitalisation of companies as well?

Large-cap companies with high market capitalisation (upwards of Rs 25,000 crore as per AMFI classification) have unique characteristics that differentiate them from the rest. 

Stability of business

They are usually leaders in their business with a strong ability to withstand economic and geopolitical shocks. On an average, annual sales of BSE 100 companies (large-cap index) were Rs 59,000 crore as against Rs 13,000 crore and Rs 3,000 crore for BSE Mid-cap and BSE small-cap respectively.

Strong leadership position has given higher pricing power or customer loyalty for these companies, which in turn has resulted in higher profitability. HDFC bank, Reliance Industries, Infosys, ITC and Larsen and Toubro are among the top companies in the BSE 100.

While their revenue growth might not keep pace with that of mid-sized companies (thanks to its already large revenues) such companies are highly profitable. Net profit margins (Net profit as a percentage of sales) of BSE 100 companies, on an average, were nearly double that of BSE Mid-cap, at 7.3 percent. 

Strong leadership position has given higher pricing power or customer loyalty for these companies, which in turn has resulted in higher profitability. HDFC bank, Reliance Industries, Infosys, ITC and Larsen and Toubro are among the top companies in the BSE 100.

Strong earnings growth

In the last twenty years, earnings of BSE 100 companies have grown briskly at 10 percent annually. Over the long-term, stock returns are commensurate to the extent of earnings growth of the company.

Since 1998-99, regardless of the state of the economy, they have reported positive growth in annual earnings over a five-year period.  

Moreover, their annual earnings growth showed the least volatility as compared to mid-cap and small-cap companies in the last four years.

Best wealth creator

large cap funds table
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*investing at the end of each year

Large-cap companies have proved to be the best bet during weak phases of the market. In 2008, when the global financial crisis rocked the equity market, BSE 100 was down by 55 percent as compared to 67 percent and 72 percent for BSE Mid-cap and BSE Small-cap respectively. Investors with a five-year investment horizon would have lost, in a worst-case scenario, 1.6 percent in a large-cap index as compared to 6.2 percent for mid-cap and 11.2 percent for small-cap.

While giving downside protection, such companies have also stacked up well on returns. In the last decade, BSE 100 (TRI or Total Return Index) gave a return of 10.2 percent as compared to 10.0 percent for BSE Mid-cap TRI and 7.1 percent for BSE Small cap TRI. Over a five-year period, mid-cap (8.8%) outperformed large-cap (8.5%) by a very small margin. 

More dividend payouts

Investors usually earn more in the form of dividends by investing in large-cap companies. 

With mature business models, the cash generated from profits of large-cap companies are often distributed back to shareholders in the form of dividends. Companies with a consistent track record of distributing dividends are preferred in a volatile market scenario. 

Fund Outperformance

Actively-managed large-cap funds – as against index funds – still have their relevance in India. In the last one year, 65 percent of large-cap funds outperformed the returns of that of BSE 100 TRI. In the last five years, 27 percent of funds outperformed the index, while it was 33 percent in the last 10 years. 

As per SEBI’s (Securities and Exchange Board of India) guidelines, large-cap mutual funds invest 80% of their corpus in large-cap companies.

Takeaway

All category of investors need to have an element of large-cap funds in their portfolio. From first-time investors to those seeking to create long-term wealth, large cap funds provide the necessary stability, diversification, and the potential to earn inflation-beating returns. 

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