Active largecap funds set to outperform for 2nd consecutive year

The majority of active largecap funds are set to outperform for the second year in a row in 2024, thanks to the strong performance of their midcap and smallcap allocations.

Data from Value Research shows that returns from 83 per cent of the 30 active largecap funds (direct plan) are ahead of the BSE 100 Total Return Index (TRI) on a one-year basis (as of December 24).

In 2023, 73 per cent of the schemes had beaten the index.

According to experts, the performance of active largecap funds is cyclical in nature, with their ability to beat the index increasing during phases of smallcap and midcap outperformance relative to largecaps.

“In an environment where smallcap and midcap stocks perform better, active largecap funds are at an advantage as they have significant exposure to smaller companies,” said Arun Kumar, head of research at FundsIndia.

The challenge arises when the largecap indices are driven by the top few stocks, and the smallcap and midcap segments of the market struggle, he added.

The broad-based rally and the subdued performance of some of the index heavyweights have also been factors.

“The environment has been conducive for active stock picking, given that the return profile of the market has been broad-based with a low concentration, i.e., the median stock return has been higher than the index or benchmark return.

"Further, new listings have allowed active managers to demonstrate their stock selection ability based on in-depth research," said Ramesh Mantri, chief investment officer of WhiteOak Capital Asset Management Company.

Mutual fund (MF) regulations allow largecap fund managers to invest up to 20 per cent of the corpus in midcap and smallcap stocks.

Most top-performing largecap schemes had a 10-15 per cent midcap and smallcap allocation at the end of November.

Midcap and smallcap indices have delivered returns that are more than double those of their largecap peers.

So far in 2024, Nifty 50 is up 9.2 per cent, while Nifty Midcap 100 has surged 23.6 per cent.

Nifty Smallcap 100 has also risen 23.7 per cent.

The largecap category is considered the most difficult category for fund managers due to the limited stock universe and negligible pricing anomalies or information asymmetry.

“The issue with active largecap funds is that there is considerable overlap with their benchmark (around 60 per cent for most schemes).

"Hence, the fund is dependent on the other 40 per cent of the portfolio to deliver excess return while also covering expenses,” said Kumar.

Reports have shown that the majority of largecap funds fail to beat their benchmarks consistently over long periods.

These studies, along with the higher costs associated with active funds, have led to a shift in largecap allocation toward passive funds.

In addition, the better performances of smallcap and midcap funds have added to the challenges for active largecap funds.

In the past two years, midcap, smallcap, and thematic funds have cornered most of the fresh investments, leaving most other categories, including largecap funds, struggling for inflows.

Midcap funds recently overtook largecap funds to become the third-largest active equity fund category.

As of November end, midcap funds were managing Rs 3.9 trillion, compared to Rs 3.6 trillion in assets under management from largecap funds.