According to SEBI’s mutual fund recategorization rules (2018), the equity mutual fund schemes that are classified as Large-cap funds have to invest a minimum of 80% of their assets in the large-cap stocks (i.e. in the top 100 listed stocks).
By definition, the large-cap stocks are the stocks of the topmost companies listed on the Indian stock exchanges and have high market capitalization. As per SEBI, a stock is termed as large-cap if it in the Top 100 list of the companies by market capitalization.
These large-cap stocks are also commonly referred to as the Blue Chips and represent the companies which are market leaders in their respective sectors or industries.
You can read more about market cap-wise differentiation between large vs mid vs small-cap stocks. In future, SEBI might revisit the definition of large caps (read about it here).
Given the restrictions on large-cap funds, it may seem that most large cap funds will have similar holdings. And that is true to a large extent. But do note that the large-cap schemes have to invest a minimum of 80% of their assets in the top 100 listed stocks. This remaining 20% can be invested in mid- or small-cap stocks as per fund manager’s choice. There are a few more points of differentiation. It is not necessary for large-cap funds to invest in at least 80 of the top 100 stocks. It’s just that it should 80% in top-100 stocks and there is a difference in that. And the difference will also be in the weights of the stocks in the fund and the index. So this too provides some scope of outperformance & downside protection based on fund manager’s ability (and differentiated strategies within the scope of the rules).
In general, the NAV of a large-cap fund does not fluctuate as much as that of a small-cap or a mid-cap fund. Hence, investing in large-cap funds does offer comparatively higher stability to your MF investment portfolio. And since volatility is lower in large-cap funds, it also means that in sharp bear markets, the ability of large-cap funds to withstand falls would be comparatively better in general.
By the way, these Large Cap funds are just one of the many different mutual fund categories in India. It is just that these Large-cap mutual funds are a category of equity mutual funds that invest predominantly in the large-cap companies.
And how are Large Cap funds taxed?
Since the large-cap funds are part of the equity funds, the taxation is as follows:
- The Short Term Capital Gains (or STCG) on large-cap funds is taxed at 15%.
- The Long Term Capital Gains (or LTCG) on large-cap funds is taxed at 10% on LTCG exceeding Rs 1 Lac.
Gains on investment in Equity Mutual Funds held for more than 1 year is classified as Long Term Capital Gains and the gains on investment in Equity Mutual Funds held for less than 1 year is classified as Short Term Capital Gains. Read more about this at Mutual fund taxation in India.
These days, there is a growing concern among large-cap fund investors. And that is about whether they should shift from active large-cap funds to passive large-cap index funds?
Why this concern?
Let me give you a bit of a historical background first.
Till few years ago, active large cap funds used to beat their benchmark indexes quite easily. Reason was first that in spite of being a large cap funds, the fund managers often added large doses of mid-cap and small-cap stocks to push up their returns. This helped when going was good for these non-large-cap stocks. Now when SEBI in 2018 redefined fund categories and restricted what fund managers could do (i.e. like need to mandatorily put 80% in large cap stocks), it restricted fund manager’s freedom and more importantly, their ability to generate alpha or outperformance by deviating from large cap mandate. Then came another rule change of using TRI or Total Return Index for benchmarking of funds.
(Do read about these 3 big changes in mutual funds which people didn’t give much importance to initially but is now impacting things).
As a result (and data is now showing this), the number of active large-cap funds beating the index has come down. Even for the ones beating the index, the
margin of outperformance over the index is getting reduced. If you are a large-cap fund investor in the past few years, you might have noticed that large-cap funds in your MF portfolio are struggling to beat their benchmark indexes.
To summarize, in the equity large-cap category, generating alpha is becoming increasingly difficult for active fund managers of India. And hence people have concerns whether it makes sense to have them in your portfolio or not.
Globally, there has been a gradual shift of assets from active to passive management as a consequence of active fund managers underperforming their index benchmarks and due to low expenses of passive investing. Index or passive investing is still in its infancy in the Indian market. But no doubt, it is gaining ground and the only way is up. Given the lower expenses and the recent underperformance of large-cap funds compared to index funds, the interest in the passive funds is growing.
I will write about Passive Index Funds vs Large Cap Funds in more detail another day. It is not as simple a discussion as it is made out to be in my view.
But I hope this post on large-cap funds refreshes what you know about this fund category and how it works and where it invests. Most investors start their mutual fund journeys with investing in large-cap funds. It’s therefore important to understand how large-cap funds invest and build their portfolios.