Why should large cap equity funds form part of your core portfolio?

Core investment is the mainstay of one’s portfolio. Ideally, it provides stability and facilitates achieving your long-term financial goals, such as retirement or sponsoring a child’s higher education. The core portfolio is seldom churned – for it ensures the security of goals under most circumstances – even if some riskier investments don’t perform as expected.

Can a large cap equity fund be the core of your investment portfolio?

Assess your need for risk

At the outset, ascertain the need for risk. Figure out the required rate of return on your investment portfolio to fulfil your financial goal under consideration. If you have considerable time at your disposal to achieve the goal but need more returns, your investment portfolio should take the commensurate risk. 

For instance, if you aim to retire with a corpus of Rs 5 crore by 2040, and can save Rs 12 lakh annually, then you need a return of 8% at least annually. This required rate of return, in turn, will define your asset allocation and the need for risk.

A debt asset with an average return expectation of about 6%-7% annually might not solely help in achieving your goal. How does your investment achieve the 8% return threshold, then? That’s where the role of equities comes into play. 

Historically, equity as an asset class has given the best inflation-beating returns over the long-term of 12%-14% annually. You can get there by calibrating your asset allocation in favour of equities. So, first of all, check if your asset allocation demands equities in your portfolio. 

Here are two advantages of having large cap equity funds in your portfolio:

Stability

Largecap equity funds are stable investment options within an equity asset class. It essentially invests in stocks of companies with the highest market capitalisation – say, top 100 companies by market cap. Usually, they are market leaders in their business with a good reputation in the market and are more resilient during business adversities (than smaller companies).

Large cap Companies like TCS, Reliance and HUL have also been in business for a long time. Having a portion of large cap ensures your investment portfolio isn’t too volatile due to market vagaries.  

Solid wealth creation

Large cap stocks have proved to be the best bet during the bear phases of the market. In 2008, when the global financial crisis rocked the equity market, BSE 100 was down by 55 per cent compared to 67 per cent and 72 per cent for BSE Midcap and BSE Smallcap, respectively. Their volatility (as measured by standard deviation) of yearly returns was also the lowest among equity sub-assets. 

What about long-term returns? 

Equity investors with a seven-year investment horizon would have never lost their money 97% of the time. It was found using rolling seven-year returns for equity indices BSE 100 (large cap), BSE mid cap and BSE small cap since 2003.

And if it had been in large cap, investors would not have lost money at all and, in a worst-case scenario, earned a CAGR of 3.7% against a lower 0.8% and -2.6% for mid cap and small cap, respectively.

Since 2003, BSE 100 has given an average seven-year rolling return of 10.9 % compared to 11.1 % for BSE Midcap and 9.9 % for BSE Small cap. While giving the best downside protection, large cap equity indexes have also stacked well on returns. Thus, large cap equities arguably give the best risk-adjusted returns for their investors. 

Need for Choice-making

Largecap equity fund diversifies investment across different stocks and industries, thereby providing the best potential for return and stability. As per SEBI (Securities and Exchange Board of India) guidelines, large-cap equity funds invest at least 80% of their corpus in large-cap stocks.

However, not all of them manage to outperform their benchmarks. As per our analysis, only about 30% of large cap equity funds outperformed the BSE 100 TRI returns in the last five years.  

So, it is not just about investing in large cap funds but also making the right choice using various performance (risk and return) measures.

Takeaway

This article was first published on livemint here on 15 Sep 2022