Large, mid, small cap fund performance
Management

Large, Mid or Small cap funds- which did better for investor’s in the past 5 years ?

Diversification is essential for all investors, in mutual funds, this is done by investing in different categories such as large, mid, and small-cap funds which will help the purpose and as well as perform to meet the minimum return expectations. The overall objective is kept in the minds of the investor while doing this.

Investors closely look into the past for making decisions for the future. In this article let us look at the performance of various categories of funds in the past. We do not intend to provide any recommendation or predict what is going to happen but only see what happened in the past for educational purposes.

The 5 year annualized returns of three known benchmark indices are as follows

NIFTY 50 0.8%
NIFTY MIDCAP 50 0.6%
NIFTY SMALL CAP 50 -7.9%

Except for the small-cap index, the other two indices performed similarly in the past 5 years. This is the case for the Nifty indices there are a lot more indices that comprise large, mid, and small-cap securities which funds track. Let us try to consider top-ranked mutual funds in each category according to the value research.

Top performers in the respective fund category

To choose these funds we use a 5-year return rank provided by value research

Large-cap funds

Out of the 49 direct plan mutual funds, the top 5 funds according to 5-year rank were

  1. Axis Bluechip large-cap fund
  2. Canero Robeco Bluechip large-cap Equity fund
  3. Mirae Asset large-cap
  4. Motilal Oswal Focused 25 large-cap fund
  5. Sundaram select focus large-cap fund
FUND 5-Year% RETURNS
Axis Bluechip fund 8.23
Canero Robeco Bluechip Equity fund 7.03
Mirae Asset large-cap 6.24
Motilal Oswal Focused 25 fund 5.51
Sundaram select focus fund 5.24

The funds might not exactly benchmark against the mentioned NIFTY 50 index. The above-mentioned funds have S&P BSE 100 TRI as their benchmark index which is inclusive of dividends. The 5-year return of the S&P BSE 100 TRI is 2.39%. The average return of the funds above is 6.45%.

Mid-cap funds

In the case of the mid-cap category of funds, Out of the 19 direct funds, the top-performing funds are

  1. Axis midcap direct
  2. DSP midcap direct
  3. Invesco invest India direct
  4. L&T midcap direct
  5. Kotak Emerging equity direct
FUND 5-Year % RETURNS
Axis midcap direct 7.42
DSP midcap direct 6.99
Invesco invest India direct 5.63
L&T midcap direct 5.16
Kotak Emerging equity direct 4.97

The above-mentioned funds have S&P BSE 150 Midcap TRI as their benchmark index which is inclusive of dividends. The 5-year return of the S&P BSE Midcap 150 TRI is 3.25%. The average return of the funds above is 6.03%.

Small-cap funds

For small-cap funds the top 5 funds on similar criteria are

  1. SBI small-cap direct
  2. Axis small-cap direct
  3. Nippon India small-cap direct
  4. L&T Emerging Businesses
  5. Kotak small-cap direct
FUND 5-Year % RETURNS
SBI smallcap direct 6.72
Axis smallcap direct 6.84
Nippon India smallcap direct 4.98
L&T Emerging Businesses 2.84
Kotak smallcap direct 2.51

The above-mentioned funds have S&P BSE 250 Smallcap TRI as their benchmark index which is inclusive of dividends. The 5-year return of the S&P BSE 250 Smallcap TRI is -3.32%. The average return of the funds above is 4.78%.

Did small-caps funds really underperform?

Clearly in absolute terms, the small-cap funds underperformed the large and midcap funds, but in case of funds we could look at the Jensen alpha ratio of the said funds to find out the returns generated above-expected returns of the mentioned funds

FUNDS CHOSEN ALPHA
LARGE-CAP FUNDS
Axis Bluechip fund 6.68
Canero Robeco Bluechip Equity fund 3.85
Mirae Asset large-cap 1.21
Motilal Oswal Focused 25 fund 1.33
Sundaram select focus fund 2.64
MIDCAP FUNDS
Axis midcap direct 9.54
DSP midcap direct 2.33
Invesco invest India direct 4.47
L&T midcap direct 0.02
Kotak Emerging equity direct 1.39
SMALL CAP FUNDS
SBI smallcap direct 14.25
Axis smallcap direct 13.75
Nippon India smallcap direct 8.47
L&T Emerging Businesses 2.88
Kotak Smallcap direct 6.12

The alpha mentioned here is computed as the difference between portfolio returns and Expected returns, which is calculated using the CAPM (Capital asset pricing model). This is also done using other pricing methods such as the Arbitrage pricing theory (APT). But the most commonly known is the CAPM method. Using CAPM, we can calculate Expected returns as

Expected Return (ER) = Risk-free rate + ß (Benchmark market risk – Risk-free rate)

The ß (Beta) mentioned here is the weighted average risk the fund has incorporated in relative to the benchmark market index. To understand better consider ‘x’ stock with ß= 1.2, this means that the stock ‘x’ is 1.2 times riskier than the benchmark market index you are comparing it with.

This relative risk is calculated for every security in the portfolio and the overall relative risk the fund has incorporated into its portfolio is used to find the expected returns from the portfolio with respect to the risk taken. If the actual returns from the portfolio are lesser than expected returns then it is assumed that the fund has not delivered much compared to the risk it has taken.

The average ‘Alpha’ delivered by large, mid, and small-cap funds are 3.14, 3.55, and 9.09 respectively.

Surely if we are going to consider this metric we will find small-caps have yielded better returns with respect to the risk they have appropriated.

Overall scenario

But instead going towards conclusion lets look at the performance of respective of large, mid, and small-cap indices. The respective benchmark indices in the fund categories delivered 2.39%, 3.25%, -3.32%. The higher ‘alpha’ of small-cap funds can also be reasoned with the underperformance of its benchmark index, which might have reduced the relative risk in the fund categories.

SMALL CAP FUNDS BETA (ß)
SBI smallcap direct 0.84
Axis smallcap direct 0.78
Nippon India smallcap direct 0.93
L&T Emerging Businesses 0.86
Kotak Smallcap direct 0.87

The ß value of the chosen small-cap funds is below 1 which indicates the risk in the fund is much lesser than the index itself.

This has also been true for large and mid-cap funds but the returns above expected levels in small-cap funds could also be due to the underperformance of its benchmark index which would have brought down the ‘Benchmark Index return’ and thus reduced the expected return or much worse expected return in negative territory.

For example, consider the Risk-free rate at 6%, the benchmark index returns as -3.32% (as like the small-cap index considered) with ß= 0.75 then expected returns

= 6% + 0.75 ( -3.32% – 6%)

=-1% (negative 1 percent)

Are we going to expect negative returns on our investments?

In such a case, we might need to consider a larger time frame of data such as 8,9, or 10-year returns and ß which will give a true picture.

The situation was the same even before the crisis. The mid-cap and small-cap indices were in a longer period of consolidation previously when the large-caps were rallying

large-cap performance

Large-cap performance graph

                                                             Midcap performance

                                                                                                            Mid-cap performance graph

small-cap performance

Small-cap performance graph

(Source: Moneycontrol)

This subdued performance of mid and small-caps would have reduced the expected return and thus could have boosted the alpha, but this is just an assumption. There are multiple other metrics that would help make investors such as Sharpe, Treynor, Sortino, etc.

The benchmark indices of the above-mentioned funds faced huge sell-off starting from March. The most resilient one was the Midcap which lost up to 22%, the large-cap lost up to 25%, and small-caps lost nearly 30% from their respective Jan 3rd market capitalization.

If we consider the rally previously in the large-cap and look at the fall in recent months, it still fared better since both mid and small-cap were range-bound.

Mid-caps even though being range-bound was resilient than the other two during fall and generated returns in par with large-cap funds.

Past need not necessarily be an indicator of the future. In absolute terms large and mid-cap fared better than small-caps. But small-caps showed better alpha than the other two due to underperformance of the index. If not for recent fall large-cap would have comfortably outperformed the other two. There is no definite winner here. Only time can tell which category funds will generate sufficient return in the future.

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