Should large cap equity funds form a 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? Let us assess:

Assess your need for risk first

At the outset, ascertain the need for risk. Figure out the required rate of return on your investment portfolio to fulfil your financial goals. 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 5 crore by 2040, and can save 12 lakh per year, then you need a return of 8% 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 may not solely help in achieving your goal. How does your investment achieve the 8% return threshold? That’s where equities come into play. Historically, equity as an asset class has given the best inflation-beating returns over of 12-14% annually over the long term. 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. One is stability and the other is wealth creation.

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Large cap equity funds are stable investment options within equity. They essentially invest in stocks of companies with the highest market capitalization which are usually market leaders in their business, and are more resilient during business adversities. Large cap companies like TCS, Reliance and HUL have been in business for a long time.

Having large cap investments ensure that your portfolio isn’t too volatile due to market vagaries. Large-cap stocks have proved to be the best bet during bear market phases. In 2008, when the global financial crisis rocked the equity market, BSE 100 was down by 55% compared to 67% and 72% for BSE Midcap and BSE small cap, 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, shows data on rolling 7-year returns for equity indices BSE 100 (large cap), BSE Midcap and BSE SmallCap since 2003. And if they had been in large caps, investors would not have lost money at all and, in a worst-case scenario, would have earned a CAGR of 3.7% against a lower 0.8% and -2.6% for mid caps and small caps, 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 SmallCap. 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.

Need for Choice-making

Large cap equity funds diversify 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 must invest at least 80% of their corpus in large-cap stocks.

However, as per our analysis, only about 30% of large cap equity funds outperformed the BSE 100 TRI returns in the past five years. So, it is not just about investing in large cap funds but also choosing the right fund using various performance (risk and return) measures. From first-time investors to those seeking to create long-term wealth, large cap equity funds provide the necessary stability, diversification and the potential to earn inflation-beating returns. Therefore, make it part of your core portfolio.

Anup Bansal is chief business officer, at Scripbox.

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