Category : New to Investing February 13, 20265 minutes read
Large and mid cap funds invest across companies of different sizes, offering exposure to both stability and growth within a single portfolio. Their performance is influenced by a combination of market conditions, economic cycles, and fund-level decisions. Factors such as economic growth, inflation, interest rates, and global developments affect investor sentiment and corporate earnings, which in turn shape fund returns. Large cap stocks generally provide relative stability during volatile periods, while mid cap stocks may contribute higher growth potential during favourable market phases.
Fund performance is also shaped by stock selection, sector allocation, and valuation discipline. Actively managed large and mid cap funds rely on the fund manager’s ability to select quality companies and maintain a balanced allocation between large and mid cap segments. Exposure to different sectors can impact returns depending on economic cycles, while investing at reasonable valuations supports long-term performance. Market volatility, liquidity conditions, and regulatory changes may influence short-term outcomes, particularly for mid cap stocks.
The investor’s investment horizon plays an important role in realised returns, as longer holding periods allow volatility to even out and compounding to take effect. Other factors such as portfolio turnover, expense ratio, and the quality of mid cap stock selection, also affect long-term wealth creation. Understanding these elements can help investors evaluate fund performance more effectively.
Large and mid cap funds are a type of investment scheme that invest in stocks of large and mid cap companies. This means that the fund portfolio is diversified across different equity markets, enabling investors to potentially benefit from the performance of two market caps. However, like all equity investments, large and mid cap funds are a high-risk scheme. This is because equity markets are vulnerable to changes in market conditions. Before investing, investors must understand what factors influence the performance of large and mid cap funds. In this blog, we will explore the various factors that may impact the fund’s performance to help you analyse how your scheme is performing before starting an investment.
Market Conditions and Economic Cycles
Broad market conditions play a significant role in determining the performance of large and mid-cap funds. Economic growth, inflation levels, interest rate movements, and global developments influence investor sentiment and corporate earnings. During periods of economic expansion, mid cap stocks may potentially benefit from increased demand and faster growth, while large-cap stocks generally have the potential to perform steadily across market cycles. Conversely, during economic slowdowns or market uncertainty, large-cap stocks have the potential to provide relative stability. This balanced exposure may enable the fund to reduce risk while aiming for long-term wealth creation.
Learn more about the types of investment risks.
Performance of Large-Cap Stocks
By investing in large cap stocks, large and mid cap funds aim to add potential stability to their portfolio. Large cap stocks belong to well-established, big companies that are generally household names, and even during market downturns or recessions, they are less likely to experience sharp declines. The earnings consistency, financial strength, and market leadership of large-cap companies directly affect fund returns, especially during volatile or uncertain periods. Relatively stable performance from large cap stocks may help limit downside risk and provide steady growth, making them an important anchor within the fund’s portfolio.
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Stock Selection and Fund Strategy
The fund strategy and stock selection play a critical role in determining how well a large and mid cap fund performs. This is because the fund is actively managed and aims to outperform the underlying index. To do so, quality stocks need to be selected, and exposure between large and mid cap segments needs to be balanced. Moreover, the fund strategy generally aims towards diversification to manage risk. A well-executed strategy that focuses on strong company fundamentals and sustainable growth may contribute positively to long-term performance.
Sector Allocation
Large and mid cap funds invest across multiple sectors such as financial services, information technology, consumer goods and services, pharmaceuticals, and manufacturing. The performance of these sectors varies across economic cycles. A fund with higher exposure to outperforming sectors during a particular phase of the economy may perform well, whereas concentrated exposure to underperforming sectors may lead to losses. A diversified approach may generally help balance risk and returns.
Valuation Levels
Valuations at which stocks are purchased generally influence the fund’s performance. If a fund invests in overvalued stocks, performance may be impacted negatively. Contrarily, investing in fundamentally strong companies at reasonable valuations may support long-term performance. Valuation discipline is particularly important in mid-cap investing as these stocks are vulnerable to higher price fluctuations.
Performance of Mid-Cap Stocks
Mid cap stocks may enable the large and mid cap fund to grow. Mid cap companies are often in their expansion phases, and focus on scaling operations, entering new markets, and improving profitability. If the mid cap stocks perform well, they have the potential to significantly boost wealth creation. However, because mid-cap stocks are more sensitive to market volatility, periods of underperformance or sharp corrections may also influence the short-term performance of the large and mid cap fund.
Market Volatility
Market volatility impacts large and mid cap stocks differently. Mid cap stocks may react more drastically to changes in investor sentiment, global events, or economic data which may lead to sharper price swings over short periods. Large cap stocks are financially stronger and generally less vulnerable to market volatility as they are established businesses and attract long-term institutional investors. The fund’s diversified exposure may help manage volatility, but short-term fluctuations are a part of equity investing, and before investing in large and mid cap funds, investors must evaluate whether they are able to withstand these fluctuations.
Liquidity Conditions
Liquidity refers to how easily stocks can be bought or sold in the market. Large cap stocks are generally highly liquid, which supports efficient trading and price discovery. Mid cap stocks may face liquidity constraints during periods of market stress, which may influence short-term fund performance. Balanced liquidity management may potentially stabilise the overall fund portfolio.
Regulatory and Policy Changes
Changes in government policies, taxation rules, interest rate regulations, sector-specific rules, geopolitics, etc., can impact certain companies or industries. Since large and mid cap funds invest across multiple sectors, regulatory developments may indirectly influence performance based on the fund’s sector exposure.
Investment Horizon
The investment horizon of the investor plays an important role in realised performance. Large and mid cap funds are designed for long-term investment, allowing the effects of short-term volatility to potentially even out over time. Investors with a longer investment horizon may be better positioned to benefit from the power of compounding and the growth potential of mid cap stocks.
Read more about the benefits of long-term investing in India.
Portfolio Turnover and Rebalancing Frequency
Portfolio turnover is the frequency at which the fund buys and sells stocks. High turnover may help capture short-term opportunities but may increase transaction costs and impact returns. In large and mid cap funds, disciplined rebalancing between large-cap and mid-cap stocks is important to manage risk.
Quality of Mid Cap Universe Selection
At least 35% of a large and mid cap fund’s portfolio must be allocated to mid cap stocks. However, not all mid cap companies have sustainable business models and long-term potential. The fund’s performance is directly dependent on the companies it invests in. Factors such as the company’s management strength, competitive advantage, and scalability are all important to consider. Choosing fundamentally strong mid-cap companies may help reduce downside risk while enhancing growth potential.
Expense Ratio
The expense ratio of a large and mid cap fund affects the potential net returns over time. While costs may seem small in the short term, they can significantly impact long-term returns due to compounding. Generally, actively managed funds have higher expense ratios as compared to passively managed index funds. Investors must check the expense ratio of a fund before investing to ensure it aligns with their goals.
Learn more about what expense ratio is.
The performance of large and mid cap mutual funds is shaped by a combination of market conditions, the performance of underlying stocks, fund management, fund strategy, sector allocation, and economic or regulatory factors. Additional elements such as stock valuations, liquidity, investment horizon, mid cap selection quality, and expense ratios play a significant role in long-term wealth creation. While these funds carry inherent market risks, understanding these influencing factors may help investors align their investment with their goals and risk appetite to make informed decisions, optimise risk-adjusted returns, and use large and mid cap funds as a strategic part of their long-term portfolio.
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