Large Cap Funds vs Nifty Index Funds: Which is a Better Alternative in a Volatile Market?

Despite this, inflows in the Mid Cap Funds and Small Cap Funds continue to hold the ground as they are yet to see any significant impact of the market turmoil. However, market experts are of the view that despite the recent corrections, small and mid-cap stocks are still trading at a premium to their historical averages, whereas large caps are now reasonably priced.

It is noteworthy that amid the high volatility and uncertainty in the equity market, Large Cap Funds have registered a lower downturn compared to Mid Cap Funds and Small Cap Funds, highlighting their resilience during market routs and economic uncertainties.

Therefore, in this market environment, investors with moderate risk appetites may be better off avoiding Mid Cap Funds and Small Cap Funds and preferring Large Cap Funds to reduce risk.

Now the question arises which mode of investment should investors prefer - should they opt for actively managed Large Cap Funds or passively managed large-cap oriented Index Funds such as Nifty 50 Index Funds?

What are Nifty 50 Index Funds?

Nifty 50 Index Funds are passively managed schemes that aim to track the performance of the Nifty 50 index by mirroring their portfolio composition. They aim to generate returns in line with the underlying Nifty 50 index, subject to expenses and tracking error.

What are Large Cap Funds?

Large Cap Funds are mutual funds that invest at least 80% of their assets in stocks of large-cap companies. They aim to outperform their respective benchmark indices, such as BSE 100 or Nifty 100, by actively managing their portfolio.

Large Cap Funds vs Index Funds: Performance Comparison

Due to their distinct investment strategies the performance of Large Cap Funds and Index Funds can differ over a period even though they follow the same market cap bias. Moreover, Large Cap Funds also have the flexibility to invest up to 20% of their assets in stocks of mid-cap and small-cap companies, as well as debt instruments, overseas equities, cash, etc.

As we can see in the table below active Large Cap Funds have fared better compared to Nifty 50 Index Funds during bearish market phases, generating a lead of 2.5-3 percentage points.

In the last 1-year period, the improvement in the performance of certain pockets of the large-cap segment that had previously underperformed, as well as the ability to manage the downside risk better by following an active strategy, has likely helped Large Cap Funds to fare better which has improved the long-term returns as well. Over the long-term time frames of 3-years, 5-years, and 10-years, active Large Cap Funds have outpaced Nifty 50 Index Funds by a margin of 1-2 percentage points.

[Read: Why You Should Choose Large-Cap Funds Over Mid-Cap and Small-Cap Funds Now]

Large Cap Funds vs Index Funds: Which one should you prefer for investment?

Returns are just one aspect of choosing the most suitable schemes for investment. One must ensure that the fund category, the underlying scheme as well as the investment strategy followed by the fund manager aligns with their personal investment objectives and risk profile to avoid undue risk.

Passive funds provide a low-cost investment offering for investors looking to earn reasonable returns from equities by tracking the respective benchmark index and/or underlying fund, making it ideal for new investors who have just started their investment journey or those who do not want to undertake relatively higher risk. It is also a simple and convenient option for investors who find it difficult to choose the right fund from the plethora of available active funds.

So, Index Funds such as Nifty 50 Index Funds are suitable for investors looking to earn returns in line with the market.

On the other hand, for investors looking to beat the benchmark index and potentially earn better real returns (also known as inflation-adjusted returns), an actively Large Cap Fund is certainly a better choice. Active investing will continue to be relevant in this day and age of intensified volatility and macroeconomic risk alongside geopolitical uncertainty.

When investing in active Large Cap Funds, note that scheme selection plays an important role because the performance of schemes within the category can differ significantly. One can prefer Large Cap Funds that have shown consistent performance over the long run.

A fund manager of a worthy, well-diversified active Large Cap Mutual Fund that follows robust investment processes and systems can reward investors well in the future even though there may be short-term underperformance as well as phases of subdued growth. Unlike passive funds, actively managed funds are better poised to take advantage of dynamic market conditions and make tactical allocations in attractive-looking stocks/sectors/market cap, depending on the outlook. This enables actively managed schemes to limit downside risk better.

As an investor, one can consider investing in a mix of Nifty Index Funds and well-managed Large Cap Mutual Funds to create a diversified portfolio that will help them tide over volatile market conditions.

When selecting Index Funds, pick the one with a low expense ratio and low tracking error to optimise the returns.

More importantly, when investing in equity funds, aim for a long-term investment horizon of 5-7 years and prefer the SIP mode of investment to benefit from the compounding of wealth. And lastly, avoid investing in too many schemes as it can make it difficult to monitor its performance and eliminate the portfolio laggards.

Watch this video to find out whether Index Funds are worth your time and money:

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DIVYA GROVER is the co-editor for FundSelect, the flagship research service of PersonalFN. She is also the co-editor of DebtSelect. Divya is an avid reader which helps her in analysing industry trends and producing insightful articles for PersonalFN’s popular newsletter – Daily Wealth letter, read by over 1.5 lakh subscribers.
Divya joined PersonalFN in 2019 and has since then used stringent quantitative and qualitative parameters to analyse funds to provide honest and unbiased research to investors. She endeavours to enable investors to make an informed investment decision and thereby safeguard their wealth.

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.