Have Large-Cap Funds Finally Found Their Feet?

Investors are drawn to Large-Cap funds primarily due to the stability and consistency provided by wellestablished blue-chip companies, particularly during periods of market volatility. Although Small-Cap and Mid-Cap stocks carry the potential for greater returns, they also entail higher volatility and risk. Rakesh Deshmukh takes a closer look at the scenario 

Investing in mutual funds is a strategic decision that involves careful consideration of various factors. Among the multitude of choices available, one crucial decision is whether to invest in large-cap, small-cap or mid-cap funds. Each category comes with its own set of risks and rewards, making it essential for investors to align their investment objectives, risk tolerance and time horizon. Opting for large-cap funds over small-cap and mid-cap funds offers investors stability, consistency and risk mitigation. 

Large-cap stocks represent well-established, financially stable companies, providing resilience during market fluctuations while small-cap and mid-cap funds promise higher growth potential but against higher risk and volatility. Over the past two months, the Indian markets have experienced a remarkable surge. Starting from November 2023, the Nifty 50 index has initiated a rally following a robust consolidation spanning four to five months, resulting in a substantial 15 per cent surge. 

Concurrently, the BSE Sensex also witnessed a notable increase of approximately 13 per cent during this timeframe. However, the scenario shifts when examining the returns in the small-cap and mid-cap categories for the same period. The Nifty SmallCap index demonstrated an impressive performance, surging by more than 26 per cent while the Nifty Mid-Cap index recorded a gain of around 25 per cent. In comparison, both small-cap and mid-cap categories exhibited nearly double the rally percentage of the BSE Sensex during the mentioned period. 

Furthermore, investors had anticipated a continued strong rally, even on the interim budget day and post the budget announcement. Contrary to expectations, the market momentum remained subdued on that day. The returns for the month of February, as of the time of writing this article, do not align with the expected upward trend. It’s important to note that there are still significant days remaining to complete the current February month, and it can be argued that the month has just begun. 

Navigating the Valuation Dilemma
Valuation is a tool not only utilised in the stock market but also in our daily lives. We consistently place importance on assessing the value of various goods, assets, securities and commodities when engaging in buying or selling transactions. Similarly, when it comes to stocks, we calculate and analyse their valuation to determine whether they are undervalued, overvalued or fairly valued before making investment decisions. 

Examining the substantial rally in the overall market, it appears to be overvalued, and this overvaluation seems to persist for a while, characteristic of a bull market. The overvaluation is particularly pronounced in the small-cap and mid-cap segments, posing a major concern. While a minor correction was observed recently, it did not provide substantial relief. The prevailing high valuations make it challenging to anticipate significant gains in the short term. It is suggested that the small-cap space may require more extensive correction, either in terms of time or price or consolidation in the future to attain more reasonable valuations, especially when compared to the large-cap counterparts. 

Justification of Earnings and Returns
So far, about 38 companies within the Nifty 50 space have released their earnings for the December quarter. Among them, 16 per cent of the companies have reported negative year-onyear earnings. Within this, only one has experienced a shift from positive to negative earnings compared to the same quarter last year. Conversely, the remaining 84 per cent of the companies have shown an enhancement in their earnings per share. 

Additionally, within these 38 companies, 17 are trading at a discount of approximately over 10 per cent relative to the current market price. Meanwhile, the remaining 21 companies are trading at a discount ranging from 10 per cent to 1 per cent based on the current market price. In the Nifty Mid-Cap 50 index, 30 companies have released their December quarter results so far. Among these, 67 per cent of the companies have reported positive earnings growth on a year-on-year basis, while the remaining 33 per cent have recorded a decline in their earnings during the December quarter. 

Notably, 60 per cent of these companies are trading at a discount, specifically above 10 per cent. Interestingly, these are the companies that have registered de-growth in their earnings per share (EPS) during the current quarter. Moreover, within the Nifty Small-Cap 50 index, the earnings announcements have been made by 34 companies. Among them, 12 per cent of the companies reported a decline in their year-over-year earnings per share (EPS), while the remaining 88 per cent revealed an improvement in their EPS. Furthermore, 67 per cent of these stocks are currently trading at a discount ranging from 10-90 per cent. 

Looking at the earnings figures, large caps are notably undervalued in comparison to the broader market. Although small-caps have experienced a notable rise, their earnings’ growth surpasses that of large-caps but appears expensive when evaluated against their earnings. To draw a definitive conclusion, it is essential to await the release of quarterly earnings from all the remaining companies. Meanwhile, other relevant data will also become accessible, enabling a more informed pursuit of opportunities within the large-cap sector. 

Return Battle
In January 2024, the small-cap, mid-cap and the Nifty 50 indices experienced closing surges of approximately 5.83 per cent, 5.17 per cent and -0.03 per cent, respectively, compared to their December 2023 closing values. Notably, the small-cap and mid-cap indices demonstrated stronger performance than the Nifty 50 index, which remained relatively flat in January. Analysing the market trends over the past three months reveals that despite the overall market outperformance, the Nifty 50 consistently lagged behind both small-cap and mid-cap indices. 

In December 2023, Nifty 50 exhibited a marginal increase compared to the other two indices. However, in January, it saw a greater decline than both small-cap and mid-cap indices, reversing the trend observed in the previous month. The same trend is evident in the top three funds that yielded the best returns across all categories, namely, small-cap, mid-cap and large-cap during the last one year. Small-cap stands out as it continues to outperform the other two categories. Although large-cap attempted to surpass mid-cap returns in December, it ultimately failed to sustain the momentum and took a downturn, as illustrated in the image above. 

Funds versus Benchmark
To gauge the performance of securities like stocks or mutual funds, we generally evaluate their performance by contrasting them with assigned benchmarks. Another vital facet of this assessment includes measuring their performance against peer funds. The main goal is to ascertain whether a fund has delivered returns surpassing its benchmark, considering the fees charged. 

Interestingly, large-cap funds have consistently outperformed their benchmark returns across all the timeframes, especially in the shorter time period, potentially indicating an early positive signal. However, it’s worth noting that despite this, the returns generated by large-cap funds are still lower when compared to those of small-caps and mid-caps, as indicated on the above two line charts. 

The Game of Money Flow
In the stock market, it is a common rule that the money flows from one sector to another, one stock to another or one category to another and one geographical space to another. Historically, according to AMFI data, there has been consistently strong monthly inflow in the small-cap and mid-cap categories, whereas the large-cap category witnessed outflows throughout the year as mentioned in the data below. However, as of now, the data for January is not yet available on the AMFI website. We must await this information to conclude whether large-cap funds attracted inflows this month and gained momentum compared to small-cap and mid-cap funds. 

Conclusion
After analysing the data presented above, we conclude that the currently available data does not offer adequate justification to assert that large-cap investments are gaining traction at current valuations. Making a well-founded decision requires more comprehensive data to support such conclusions. Therefore, it is crucial to exercise patience and await additional information to gain a better understanding of whether investors are genuinely transitioning from small-cap and mid-cap spaces to the large-cap segment. Although the returns of large funds are showing outperformance compared to their benchmarks, drawing core conclusions necessitates further data analysis.