Large-cap equity funds, which represent one of the biggest mutual fund categories, have already had a difficult time outperforming their benchmarks in the last one year. SEBI's rejig may make this outperformance even more of a challenge.
Under SEBI's new norms, large-cap funds have the tightest mandate of all the equity categories. They have to choose their stocks from the list of top 100 published by AMFI and also have to ensure that 80 per cent of their portfolio is invested only in these stocks. Before the rejig, the large-cap category featured a fair variety of funds. Some funds managed compact portfolios drawn mainly from the Nifty 50, but many invested in the top 100 or even 200 stocks by market cap.
Post these changes, focused funds (such as ICICI Prudential Focused Bluechip) in the large-cap category have opted for a more diversified portfolio. ICICI Prudential Focused Bluechip, for instance, has transformed into plain ICICI Prudential Bluechip Fund. Funds tracking the BSE 200 or a similar broad benchmark have narrowed their focus to stick to the top 100 stocks in the future. The popular HDFC Top 200 Fund will now limit itself to the top 100 stocks and has been renamed as HDFC Top 100 Fund.
While you will have to check for such fundamental-attribute changes to the schemes you own, you also have to brace for other changes. The category may see a shrinking alpha (outperformance over benchmarks) over time, as considerable assets chase the same set of top 100 stocks in the market. Large-cap funds managed over Rs2.6 lakh crore in assets as of end-April 2018, and 80 per cent of this money (about Rs2.1 lakh crore) will now have to be parked in the 100 most actively traded stocks in the market. Given that the top 100 stocks are also very widely tracked and followed by an army of analysts, identifying outperformers is bound to get more challenging from here on.
SEBI's mandate that all funds benchmark their returns to total-return indices a few months ago has already seen large-cap funds narrow their margin of outperformance vis-a-vis their benchmarks in the last year. The average category return for large-cap funds in the last one year (as of May 30), at 10.45 per cent, was already a tad below Nifty 50 returns of 10.48 per cent. The gap may shrink further as more funds complete their portfolio rejig. With ETF products offering stiff competition to active managers on costs, index ETFs could emerge as more efficient alternatives to large-cap funds in the future.
Therefore, investors in large-cap funds need to closely monitor their fund performance in the coming months. If they are found wanting, those who prefer active managers can consider the somewhat riskier large- and mid-cap funds, which still have the flexibility to slide between large caps and mid caps, with a minimum 35 per cent allocation to each. The fact that these funds can invest only in the top 250 stocks under the new regime is a comfort and will set limits to their risk taking.
If you are cost-conscious and find it difficult to select the right fund, a combination of a Nifty 50 ETF and Nifty Next 50 ETF may present a good alternative to owning an active large-cap equity fund.