Large-cap mutual fund plans or Index funds: Which one is good for long-term investment?

New Delhi: Financial planners mostly suggest diversified largecap mutual fund schemes for first-time mutual fund investors for creating wealth in the long term. However, in the recent past most of the large-cap plans have failed to outperform their benchmark. This has come despite large-caps outperforming mid- and small-cap stocks. This has raised a question of whether one should invest in large-cap funds or index funds that try to replicate the portfolio of a particular index and match its return.

As per a report in the Economic Times, over three- and five-year periods, large-cap funds have underperformed their benchmarks — the Sensex and Nifty. Only 4 out of 27 actively-managed large-cap funds were able to beat their benchmark indices over a three-year period, the publication mentioned citing data from Accord Fintech. Over a five-year period, only 6 out of 27 funds were able to beat their benchmark indices. They fared better in the past one year with 20 out of 28 beating their benchmarks, the business daily mentioned.

Underperformance of large-cap schemes over their benchmarks has made many financial planners recommend index funds to investors as part of the large-cap portfolio allocation. With many fund managers ending up mimicking the benchmark, wealth managers feel investors would be better off making large-cap allocation through low-cost index funds. “Cost of an index fund is low, there is no cash in portfolio and fund manager bias is eliminated,” the publication quoted Harshvardhan Roongta, financial planner at Roongta Securities as saying.

The biggest advantage of an index fund over an actively managed large-cap fund is its low cost. Fund management cost of an index fund is as low as 0.17% whereas actively-managed equity funds charge somewhere between 150 to 225 basis points as fund management charges.

Some wealth managers say if you are going for an actively-managed fund then choose multi-cap funds rather than large-cap funds as these funds have the flexibility to choose stocks across the large-cap, mid-cap and small-cap category. “Risk-averse investors can go with index funds while those with an appetite for risk could make their large- cap allocation through focused funds that have concentrated portfolios,” the publication quoted Deepak Chhabria, director, Axiom Financial Services as saying.

It may be noted that after the recent categorisation of mutual funds, large-cap funds need to invest a minimum of 80% of portfolio into the top 100 stocks by market-cap, due to which the category is struggling to beat the broader index which has a low cost. Earlier, many large-cap funds took exposure to mid- and small-cap stocks to generate better returns.