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A large-cap fund's portfolio is typically drawn from a very narrow set of stocks, unlike other categories, which select from a much wider base. For instance, some largecap funds cherry pick stocks from the 50-share Nifty index or 30-share Sensex index, others from the BSE100 or Nifty100. A mid-cap fund, on the other hand, draws from a wider universe, such as Nifty Midcap or BSE200. Playing within this narrow window leaves little scope for funds in this category to have starkly varying portfolios. However, while the large-cap category may seem like a bunch of identical offerings compared to the multi-flavoured mid-cap funds basket, this is not at all the case. Look deeper, and you will find huge differences in the investing style, risk controls and flexibility in investment mandate. It may seem like all large-cap funds are sailing in the same boat, but there are differences in the approach of these funds.
Due to the inherent nature of its underlying stocks, a large-cap fund has limited ability to outperform the benchmark index, as compared to a mid-cap fund. However, fund managers try to generate alpha through various means. First, some large-cap funds enjoy higher flexibility in investments than others. Some seek to generate higher out performance over the benchmark and peers by taking higher exposure to mid-cap stocks as compared to others. Some funds enjoy more leeway to invest in nascent large-caps, which can make a big difference to the fund's return profile. There are very few pure-play large-cap offerings in this space. Many of these funds invest up to 15-20% in mid-caps as an avenue for generating higher alpha in the long run.
The funds that prefer to stick to the large cap mandate are the ones that contain downside well. Franklin India Bluechip Fund, for instance, is known to run a strict large-cap mandate. Others may exhibit higher volatility in returns, which may not suit the investor's risk profile.
Apart from this, some funds try to generate higher returns by taking larger active positions in certain stocks. An active position implies the extent to which the portfolio allocation to a single stock or sector varies from its weight in the scheme benchmark index. So, if a certain stock carries a 5% weight in the benchmark index, but the fund has invested 8% of the portfolio in the stock, it has an active weight of 3% in the stock. Typically, large-cap funds take smaller active positions compared to other fund categories, but this varies from fund to fund. By taking a more active position in select stocks, a fund manager can enhance the contribution of these stocks to the fund's overall returns and make the most of any rally in price. Fund performance is not only determined by stock selection but how the individual stocks are weighed within the portfo lio. This is why some large-cap funds managed to deliver positive returns over the past year, even as others struggled. A higher degree of concen tration in holdings may work wonders if pulled off well, but can also drag returns down if the calls go wrong. For instance, concentrated exposure to stocks like SBI and ICICI Bank has seen HDFC Top 200 slide down the performance charts for the past few years.
Even within the large-cap space, there are differences in fund traits that lend varying degrees of aggression to each portfolio. As a rule, a large-cap fund should carry less risk. The very purpose of large-cap funds is to contain volatility and lend some stability to the portfolio. The fund you pick should be in a position to do so. If you come across a large-cap scheme providing flashy return, stay away. Looking at the upcapture and downcapture ratio when choosing the fund. This ratio shows you whether a given fund has outperformed a broad market benchmark during periods of market strength and weakness, and if so, by how much. A quality large-cap fund will typically offer 90-100% of the market upside but capture much less of a market downside, thus delivering alpha over a market cycle. You should be cautious if the fund offers anything beyond this.
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