Investing in mutual funds can be complex due to the wide range of categories. Large and midcap funds offer a balanced approach, combining growth potential with relative stability. This hybrid category appeals to investors seeking exposure to both established blue-chip companies and emerging growth opportunities without fully committing to either.
It is important to understand how these funds operate, their risk-return profile, and whether they align with your financial goals before investing. This overview will help you determine if large and midcap funds are suitable for your portfolio.
What is a Major and Midcap Fund?
A large and midcap fund is a hybrid equity mutual fund category. The Securities and Exchange Board of India (SEBI) introduced this category in 2017 as part of its mutual fund reclassification. It allows investors to participate in both large cap and midcap segments within a single fund.
The key feature of this category is the 35-35 allocation rule. SEBI requires these funds to invest at least 35% of their assets in large cap stocks and at least 35% in mid cap stocks. The remaining 30% can be allocated flexibly, allowing fund managers to adjust based on market conditions and strategy.
This structure differs from other equity fund categories:
- Pure large cap mutual funds must invest at least 80% in large cap stocks, offering greater stability but potentially lower growth.
- Midcap-only funds invest 65% or more in midcap stocks, offering higher growth potential but with increased volatility.
- Large and midcap funds sit right in the middle, attempting to capture the best of both worlds.
The flexible 30% allocation allows fund managers to adjust exposure based on market conditions. Managers may favour large caps during uncertainty or increase midcap holdings when valuations are attractive. This flexibility is an advantage but requires careful evaluation when selecting a fund.
How SEBI Categorises Large Cap and Midcap Stocks
SEBI’s market capitalisation-based classification system sets clear boundaries and enhances transparency for investors. Companies are ranked by market capitalisation on Indian stock exchanges, ensuring an objective classification.
Large cap stocks are defined as the top 100 companies. These typically include household names like Reliance Industries and TCS. These companies have well-known business models with strong cash flows, which translates to lower volatility during market downturns.
Midcap stocks are companies ranked 101-250 by market capitalisation. These firms have progressed beyond the startup phase but have not yet reached large cap status. They often demonstrate strong growth potential and may become future large cap companies.
This classification system is dynamic and reviewed periodically. As companies grow in market value, they may shift between categories. Fund managers must regularly rebalance portfolios to comply with SEBI mandates. For large and midcap funds, this rebalancing maintains required allocations but can sometimes result in purchases driven by regulatory requirements rather than investment merit.
Risk Profile of Large and Midcap Funds
It is important to consider how the two components interact. This category balances risk by combining the stability of large cap holdings with the growth potential of midcap stocks.
These funds typically exhibit volatility between that of pure large cap and pure midcap funds. The large cap portion stabilizes performance during market corrections, as these companies tend to decline less than their smaller peers. The midcap allocation drives growth and can outperform during bull markets when risk appetite increases.
During varied market cycles, large and midcap funds behave differently:
- Strong bull markets may lead to underperformance relative to pure midcap funds, as the large cap component drags down returns.
- During market corrections or bear markets, the large cap allocation provides downside protection, helping the fund decline less than midcap-heavy portfolios.
This structure suits investors seeking participation in market upswings while providing some protection during downturns.
However, investors should be aware of concentration risk. Some funds may have significant exposure to specific sectors, such as banking, depending on opportunities in both large and midcap segments. The midcap portion also carries liquidity risk, as these stocks can be difficult to buy in large quantities without affecting prices, especially during market stress.
Returns Reality: What Investors Should Expect
When evaluating large and midcap funds, review historical performance data, keeping in mind that past returns do not guarantee future results. Over the past decade, performance has varied with market conditions.
Historical data shows return across assorted time periods:
- 3-year rolling periods typically range between 8% to 18% annually, depending on the market cycle.
- 5-year periods delivered returns in the 12% to 15% range.
- 10-year returns averaged around 13% to 16% for many funds in this category.
These figures vary among individual funds. Fund manager expertise and investment approach also influence returns.
Compared with the large cap mutual fund category, large- and midcap funds have historically delivered higher returns during periods when midcap stocks outperform. However, they have also experienced greater volatility. Against pure midcap benchmarks, large and midcap funds typically show more stable returns with lower peaks but also shallower troughs during corrections.
Market conditions play a crucial role in performance. During the 2017-2018 midcap rally, many large and midcap funds delivered exceptional returns exceeding 20% annually. However, during the 2018-2020 midcap correction, the category saw muted returns as the midcap segment struggled.
The large cap component offers some protection but may not fully offset midcap weakness. Due to this cyclical nature, patience is required to manage volatility and benefit from the category’s balanced approach.
Who Should Invest in Large and Midcap Funds?
Large and midcap funds are not suitable for all investors. Assess whether you match the ideal investor profile. These funds are best for those with a moderate risk appetite and an investment horizon of at least 5 to 7 years.
If you are uncomfortable with portfolio declines of 15-20%, this category may still cause concern. While less volatile than pure midcap funds, large and midcap funds can experience significant drawdowns. However, if you can tolerate short-term volatility in exchange for the potential of higher long-term returns than pure large cap funds, this category is worth considering.
These funds are well-suited for investors seeking balance. If you have a core portfolio of large cap funds and wish to add growth without fully committing to midcap funds, or if you have moderate risk tolerance but want to avoid the volatility of aggressive growth funds, large and midcap funds can serve as an effective middle ground.
Comparing investor profiles across equity fund categories:
- Pure large cap funds suit conservative investors with shorter time horizons (3-5 years) who prioritise stability over aggressive growth.
- Aggressive growth or pure midcap funds suit investors with high risk tolerance, longer horizons (7-10 years), and the emotional resilience to handle notable volatility.
- Large- and midcap funds fall somewhere between these two profiles.
Under current Indian tax laws, equity mutual funds, including large- and midcap funds, are taxed as follows. Long-term capital gains (LTCG) above Rs 1.25 lakh per financial year are taxed at 12.5% without indexation benefit. Short-term capital gains (STCG) on holdings held for less than 12 months are taxed at 20%. These rates apply uniformly across equity fund categories, so tax treatment shouldn’t be a differentiating factor when choosing between large and midcap funds and other equity categories.
Key Considerations Before Investing
Before investing in any large and midcap fund, practical factors deserve your attention. Look beyond just past performance numbers.
- The expense ratio is the annual fee charged by the fund house, expressed as a percentage of assets. For large and midcap funds, expense ratios typically range from 0.5% to 2.5%, depending on whether you select direct plans. Over 10 years, a 1% difference in expense ratio can reduce your final corpus by 8-10%. Always compare expense ratios among similar funds and, when possible, prefer direct plans.
- The fund manager’s track record is important, as managers have flexibility in allocating the remaining 30% and selecting specific stocks. Their expertise directly affects returns. Review the manager’s tenure, performance across market cycles, and investment philosophy.
- Portfolio turnover measures how frequently the fund manager buys and sells stocks. High turnover (above 80-100% annually) suggests an active trading approach, which can increase transaction costs and reduce returns. A turnover rate of 40-70% is acceptable for this category. Also, review the fund’s exit load structure, which typically charges a 1% fee on redemptions within 1 year.
- Taxation rules apply to equity mutual funds. Long-term capital gains exceeding Rs 1.25 lakh in a financial year are taxed at 12.5%. Short-term gains (for holdings less than 12 months) attract 20% tax. Remember that switching between mutual fund schemes is treated as a redemption followed by a fresh purchase. This triggers capital gains tax.
- Asset allocation is important; a large and midcap fund should be one part of a diversified equity portfolio. Consider including large cap and debt funds based on your risk profile. A typical approach is to allocate 30-40% of your equity portfolio to large and midcap funds while maintaining core holdings in large cap funds.
Carefully review these factors before investing. Consider starting with a small allocation to assess your comfort with the fund’s volatility and performance.
Conclusion
Large and midcap funds occupy a unique position, providing investors with structured exposure to both leading large cap companies and emerging midcap growth opportunities. The SEBI-mandated 35-35 allocation rule ensures consistent participation across both segments, resulting in a balanced risk-return profile between pure large cap and more aggressive mid-cap funds.
These funds offer the potential for higher returns than pure large cap funds but still require a moderate risk appetite. An investment horizon of 5 to 7 years is recommended, as performance varies with market cycles, and patience is essential. Before investing, evaluate expense ratios, fund manager credentials, and how the fund fits within your overall asset allocation strategy.
No single fund category is universally suitable. Large and midcap funds are most effective as part of a diversified portfolio, complementing other equity investments. With realistic expectations and thorough due diligence, these funds can help build wealth while managing risk. Begin by researching top-performing funds in this category and comparing their expense ratios before investing.