Can I use a large and mid cap fund instead of an index fund?

A reader writes, “Sir, you have repeatedly pointed out that it is hard for most active funds to beat the index, and this applies not only to large cap funds but also to mid cap and even small cap funds (when benchmarked with a mid cap index). However, can I use a hybrid like an actively managed large and mid cap fund instead of a large cap index?”

First, let us point to the articles mentioned above:

• Is it game over for active large cap mutual funds?
• Myth Busted: Active mid cap mutual fund managers can easily beat the index.
• Why investing in small cap mutual funds does not make sense!

Next, we need to fix a suitable benchmark to determine how active large and mid cap funds have performed. These funds must hold 35% of large caps and 35% of mid cap stocks at all times. Typically the large cap holding hovers close to 50%, and there is a small exposure to mid caps as well.

We prefer the Nifty Large Midcap 250 Total Returns Index as it has an aggregate weight capping of 50% for both large caps (Nifty 100 universe) and mid caps (Nifty 150 universe). We can also use the Nifty 200 Total Returns Index bit this is purely free-float market cap weighted and so not too different from Nifty 100 or Nifty 50.

The S&P BSE 250 LargeMidCap has 250 stocks weighted only by market cap, so its performance will be close to the Nifty 200. The S&P BSE 250 LargeMidCap, 65:35 is 65% of S&P BSE 100 LargeCap and 35% of S&P BSE 150 MidCap. This is also an appropriate index for evaluating active large and mid cap funds.

So in this article, we present performance consistency results of 22 actively managed large and mid cap funds compared with (1) Nifty 200 TRI, (2) S&P BSE 250 LargeMidCap, 65:35  and (3) Nifty Large Midcap 250 TRI.

We shall use rolling return outperformance consistency as a metric. The fund returns are compared with category benchmark returns over every 3Y, 4Y, and 5Y period. Higher the outperformance consistency, the better. Suppose 876 fund returns were compared with 876 benchmark returns, and the fund has beaten the benchmark 675 times. The consistency score will be 675/876 ~ 77%.

• There are 22 large and midcap funds with at least 500 rolling return entries over three years, 21 such funds over four years and 20 such funds over five years.
• Comparison with Nifty Large Midcap 250 TRI.
  • Three years: 7 out of 22 funds have an outperformance consistency score of > 70%
  • Four years: 8 out of 21 funds have an outperformance consistency score of > 70%
  • Five years: 9 out of 20 funds have an outperformance consistency score of > 70%
• Comparison with Nifty 200 TRI.
  • Three years: 10 out of 22 funds have an outperformance consistency score of > 70%
  • Four years: 8 out of 21 funds have an outperformance consistency score of > 70%
  • Five years: 11 out of 20 funds have an outperformance consistency score of > 70%
• Comparison with S&P BSE 250 LargeMidCap, 65:35 TRI.
  • Three years: 9 out of 22 funds have an outperformance consistency score of > 70%
  • Four years: 7 out of 21 funds have an outperformance consistency score of > 70%
  • Five years: 8 out of 20 funds have an outperformance consistency score of > 70%

So less half the number of active large and mid cap funds have a consistent outpeformance record!

Investors currently holding large and mid cap funds may review their performance individually (depending on when they started investing) and then take a call. Those looking to invest fresh must appreciate that these funds, like all other actively managed funds, will go through periods of ups and down wrt the index.

We cannot bring ourselves to recommend actively managed large and mid cap funds instead of any index fund because of the poor performance record of the category. We also do not recommend passive funds in this category (e.g. Edelweiss NIFTY Large Mid Cap 250 Index Fund) as they do not have enough tracking error history. Since most stocks beyond the Nifty 50 have a large impact cost, it will be tough for a fund manager to track 250 stocks passively.