When the time comes to invest in a mutual fund, the question that always pops up is whether I should invest in a large-cap fund or mid-cap or small-cap fund.
Though it’s difficult to answer in one word yet an in-depth analysis of certain factors such as investment objective, risk-appetite, financial condition and much more can lead to a successful selection of a large-cap mutual fund and this I am saying from my first-hand experience.
2 years ago, when I had thought to invest in the fund, a wave of questions had rolled up my mind too. One of my friends then who also happen to be a pro in share trading and mutual fund investment suggested me a few simple tips for selecting the best large-cap mutual funds. 2 years later, now when I am writing this article, I feel that this is the ideal time to recapitulate some of those tips and pen them down for your convenience.
Keep a check on the past performance:
As we all know, research work is important in share trading and investment, and the large-cap fund is not an exception to that regard. Check the performance of the funds over last 10 years in terms of returns, the stability of returns and consistency.
But selecting a fund based on its past performance and not taking other factors such as charges and downside risk into consideration would be a little imprudent task as well. Avoid making mistakes like many other mutual fund investors who latch on to a mutual fund scheme that gives high returns in a very short period of time.
Consistency is key:
Would you like to invest in the large-cap funds which gave over 100% returns during when the equity markets were witnessing a bull run but showed a sharp drop in the Net Asset Value (NAV) when the markets were volatile? Certainly, not! An ideal large-cap fund is one that consistently out-performs the benchmark over 3 to 5 years.
We can’t agree more to this – large or small, long or short, every kind of investment scheme comes with a pinch of risk and if that risk is not in proportion to the return, then think twice before indulging into that particular investment. This goes the same for the large-cap fund as well.
Risk-adjusted returns can be calculated against the return given by a risk-free instrument such as government-backed debt papers or term deposits of banks. What indicates the risk-adjusted return is the Sharpe Ratio, which is nothing but the excess return given by the fund over the return offered by a risk-free instrument. The higher is the Sharpe Ratio; the better is the risk-adjusted return.
As a rule, the large-cap fund carries relatively lesser risk as compared with the small or mid-cap fund yet each fund lends a unique trait of aggression to the portfolio. While the main purpose of the large-cap fund is to check the volatility and give stability to the portfolio, make sure the fund you pick is able to do so. If you find a large-cap fund that has been giving a flashy return in a very short span of time, especially when the market was a downside, stay away.
The best large-cap mutual funds should offer 90 to 100% of the market when it is upside and capture much less when the market is a downside.