Why Large & Mid-cap index fund is a better bet in current volatile times

Focus on the core

Before getting into why an index fund makes an appropriate investment avenue in an equity portfolio, let us understand the right investment process for an individual. To begin with, it is difficult to predict if the stock markets are going to be volatile in the near future. It is anybody’s guess. Hence, instead of trying to time the markets, it is better to make investment decisions based on asset allocation which an individual may have created in the context of financial goals and risk-taking ability.

And, now, the moot question comes into play: What to buy in equities?

Balancing risk and reward

Investors are worried about investing in stocks after a rewarding year because they look at rising geopolitical risks, a complex interplay of interest rates cycle and valuations in the context of earnings visibility.

In a year in which more than 50 countries including India go for elections, its outcomes cannot be ignored. These can materially change the way companies conduct business worldwide. Also, any escalation in the ongoing wars can materially impact supply chains worldwide. A full-fledged war like situation can not only impact trade but also raise prices of various commodities in many parts of the world.

This brings us to another more important variable – inflation. A sticky inflation along with high commodity prices can delay the much-awaited cut in interest rates. It can impact liquidity in the markets. It can keep money dearer for companies and can impact earnings growth.

Lower earnings growth than what was expected at the beginning of the year would mean lower valuations of companies.

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This calls for exposure to companies with relatively larger sizes, strong balance sheets, established businesses and earnings growth. Large and mid-cap stocks not only offer these but also command relatively attractive valuations, compared to their small-cap peers. Large-cap stocks form the core of any equity portfolio and offer relative stability, whereas mid-cap stocks can offer the much sought after growth.

Index fund approach

When an investor looks to allocate her money to diversified large-and-midcap stocks through mutual funds, she typically comes across a flexi-cap. However, these schemes have a relatively high allocation to large-cap stocks, in some cases as high as 70 percent. Also, some of these schemes may have allocation in small-cap stocks.

Instead, a large-mid-cap equity fund is better placed from the long-term perspective.

Now, the fundamental question of selecting the right scheme which provides the advantages of large-and-mid-cap companies may emerge in the minds of investors.

Largely, identifying the right actively managed large-and-mid-cap scheme is a task. Winners keep on changing year after year. In the past three-year and one-year periods ended on April 12, 2024, less than half of actively managed schemes have managed to beat the Nifty LargeMidcap 250 index (NLM). In the past one-year and three-year periods, the Nifty LargeMidcap 250 index has given 45.9 percent and 22.7 percent returns respectively.

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Even the composition of the Nifty LargeMidcap 250 index is favourable to generate reasonably good returns in the long term. The index gives equal weight to large-cap and mid-cap stocks. While the top 100 stocks account for 50 percent of the weight in the index, the remaining goes to 150 midcap stocks. This approach ensures that the index becomes a true representative of large-cap and mid-cap stocks. The index is reset on a quarterly basis.