Largecaps are considered to be less risky than the mid and small caps; rightly so. Since largecap companies have stable businesses and greater financial muscle to weather economic downturn; their stock prices tend to fluctuate lesser than those of midcaps. Usually, Investors with moderate risk appetite invest in largecaps. Likewise, largecap oriented mutual funds too are popular with investors for the same reason. Your investment advisor and the mutual fund distributor must have recommended you to invest in largecap oriented funds calling them a stable investment proposition. But are they really stable? Let's find out...

Equity markets have been reeling under pressure for variety of macro-economic reasons. Persisting pressure of financing huge Current Account Deficit (CAD) and cooling domestic economy have been keeping equity indices in red. Many of you must have noticed that even your largecap funds are doing poorly these days as compared to S&P BSE Sensex, especially since the beginning of 2013. So negative performance may not come to you as a surprise but underperformance of largecap funds may have disappointed you. Before you conclude that the funds that you have invested in are incapable of generating returns (and therefore such funds should be discarded from your portfolio); wait a minute and check the performance of other largecap funds.

Study carried out by PersonalFN shows that, broadly, largecap funds have underperformed S&P BSE Sensex, a largecap index that is widely used to benchmark the performance of largecap funds. For the purpose of this study, PersonalFN considered all those diversified equity funds (other than those belonging to midcap, opportunities and flexicap categories) which have at least 75% of their assets in largecap stocks as per their last disclosed portfolio.

Nearly 90% of largecap funds have underperformed S&P BSE Sensex over last 3 months. The percentage of those outperforming the index is even worse on Year-to-Date basis. However, when compared to the performance of S&P BSE 100, the picture looks better. As many as 60% of the funds have outperformed S&P BSE 100 over last 3 months while nearly 42% have outpaced the index on Year-to-date basis. This shows that there must be a considerable difference between the returns generated by S&P BSE 100 and S&P BSE Sensex.
 

S&P BSE Sensex Vs. S&P BSE 100

(Base: Rs 10,000)
(Data as on August 30, 2013)
(Source: ACE MF, PersonalFN Research)  

As depicted in the graph above, movement of S&P BSE 100 shows remarkable deviation on 3-Month period. This has been primarily the reason for such a huge underperformance of largecap funds as a category. To understand what difference it makes, first you need to understand the composition of these indices.

Although a bellwether index, S&P BSE Sensex is a highly concentrated index. Out of total 30 stocks, top 10 stocks carry about 70% of the weightage in the index on the other hand the weightage of top 25 stock is about 70% in S&P BSE 100. This shows that the performance of S&P BSE 100 is more comprehensive and thus represents the broader universe. Moreover, same stocks have a different weightage in S&P BSE 100 and S&P BSE Sensex. This entails that the performance of S&P BSE Sensex is better in comparison due to outperformance of handful stocks. Further, PersonalFN noticed that, only 24 of 100 stocks (of S&P BSE 100) outperformed S&P BSE Sensex on Year-to-Date basis. This indicates that the market breadth has been poor. It is noteworthy that as many as 53 stocks of S&P BSE 100 have lost in excess of 20% since the beginning of 2013.

In other words, this means, to outperform S&P BSE Sensex, one must have invested in lesser number of stocks taking high exposure to only select stocks. However, this may have defeated the basic tenet of mutual fund investing i.e. diversification.

PersonalFN is of the view that it is natural on your part to expect your mutual funds to do well under all market conditions. But under difficult circumstances such as the prevailing ones, you must learn to ignore the short term underperformance of your funds. However, PersonalFN is also of the view that, holding a largecap fund blindly assuming they are stable, is not desirable. You should invest in a fund that has a proven long term record and which comes from a fund house that follows prudent investment processes and systems. Selection of the right fund plays a crucial role.

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