With large-cap funds underperforming the benchmark index, investors can look at passive funds when constructing their core equity mutual fund portfolio, according to investment advisers.
"Active large-cap funds are a no-no at this point in time," Aditya Shah, chief investment officer at JST Investments, told BQ Prime in The Mutual Fund Show. "There are loads of index funds now available in the market, and active funds can be looked at in the other categories, not in the large-cap category."
Shah said the core portfolio should consist of Nifty 50 and Nifty Next 50 index funds. Investors can choose a fund based on tracking error and expense ratios, he added.
"How are we beating the tracking error? The funds, which have a higher AUM, they will be able to do it very easily," Shah said.
"So, in my case, if I were to recommend two funds, we could go for the Nifty 50 index fund and the UTI Next 50 index fund," he said.
Investors can consider certain passive funds as well as active funds while keeping in mind their financial goals, said Amol Joshi of PlanRupee.
A pure equity investor with an aggressive risk profile can invest about 50% to 60% of the portfolio into the large-cap space as pure passive... but within that also you can have a split," Joshi said on building one's core portfolio.
"There are various types of analysis that you can do, a scheme that does well across market cycles, especially based on rolling returns can have some exposure from the large-cap space within actively managed funds," the analyst said. "Remaining 35–40% of the space, you can build it around a mid-cap and small-cap diversified portfolio."
The core equity portfolio can also be completely passive, especially if "you believe that the future is very, very difficult for a fund manager to generate alpha", said Joshi.
Watch the full show here:
Edited Excerpts From The Interview:
Aditya, the SPIVA report talks about 88% of large-cap actively managed funds having underperformed the benchmark, the benchmark in this case is the BSE 100. Should you take that with a pinch of salt, or would you say that this is now par for the course?
Aditya Shah: I think this is par for the course because I believe that the large-cap funds will not be able to sustain substantial alpha over the index and therefore there is no point investing in them.
First, you need to understand the functioning of large-cap funds. If you are going to direct and pay everybody 1% as an expense ratio and if you go to a regular that pay about 2% of expense ratio, given the fact that under the SEBI's de-categorisation norms, 75% of the investments need to be in the large-cap category.
It is very hard for these funds to generate about 2% of past performance. So now what is really happening is, increasingly funds are finding it very, very difficult to beat the index and that is going to stay par for the course because of SEBI’s de-categorisation norms.
So, all in all, in my opinion, active large-cap funds are a no-no at this point in time. Whereas index funds, there are loads of index funds now available in the market, and active funds can be looked at in the other categories, not in the large-cap category.
Amol, why is this underperformance taking place? Is there any way for them to change this trend that has now emerged over the course of the last several years?
Amol Joshi: You mentioned, should we take it with a pinch of salt or par for the course? I would say there is a bit of both. We heard one side about the expense ratio from Aditya. I can add a couple more points.
Let me say that not just actively managed funds, but actively managed funds as well as passive funds like an index fund, by design will not be able to beat the benchmark. I am talking in this case of passives because we are excluding one very important component and that is the expense ratio component.
A professionally managed product available to retail from Rs 100 to without any limit, you will essentially have some kind of expenses over there. So, expenses are not looked at, number one.
Number two, schemes also have sectoral or group limits. We recently saw one of the largest groups, and all the companies in that group have faced pressure on their share price, anywhere from 60% to all the way to 85%. To avoid that, there are norms via which a scheme cannot have more than 10% or more than 15 or 20% for sectoral and group exposure. An index can certainly have that.
The largest stock in the index Nifty 50 is currently contributing 60% to the weightage, so these are certain limitations because nobody can hide from the fact that people essentially come to actively managed funds to score something over and above.
But you should also look at points like expense ratio, impact costs and exceptional circumstances that we mentioned. Having said that, certain passive and active funds are both products, both routes are open to you as an investor. Anything that takes you closer to your financial goals is the right choice for you.
Aditya has very clearly said that a passive approach is what you should take, do you concur with that? And in this case, if we are talking about core versus satellite, how do you construct that?
Amol Joshi: So, core versus satellite. Within equity also you have people with various degrees of risk appetite, because we have wide choices from equity-oriented funds that do have some kind of debt component in it. But a pure equity investor with an aggressive risk profile can invest about 50% to 60% of the portfolio into the large-cap space as pure passive is your choice but within that also you can have a split.
There are various types of analysis that you can do, a scheme that does well across market cycles, especially based on rolling returns can have some exposure from the large-cap space within actively managed funds. Remaining 35-40% of the space, you can build it around a mid-cap and small-cap diversified portfolio.
Would you concur in saying that that core can be completely passive?
Amol Joshi: What you will see is that can be completely passive. There is nothing that stops you from making that choice. So yes, it can be completely passive, especially if you believe that the future is very, very difficult for a fund manager to generate alpha given all the constraints.
What is the best approach when you are constructing a portfolio of mutual fund schemes or even one single mutual fund scheme? Should you have only a Nifty 50, combination of Nifty 50 plus, Nifty Next 50, what is the ideal solution according to you?
Aditya Shah: See, even if this SPIVA data compares it to the BSE 100, even if you compare it to the Nifty 50 index, we will find most of the large-cap funds are underperforming is the first part and second part is what is a good strategy.
As you have correctly said, the Nifty 50 index fund should be a core part of your allocation. Together with the Nifty 50, Nifty Next 50 index funds should be part of your portfolio. Both funds are available from multiple AMCs.
You can go ahead and invest based on the tracking error and the expense ratios that a company may be providing you for, but in my base case, there will be the Nifty 50 index fund and the Next Nifty index will either go or not go for the Sensex fund because the Sensex fund is not that correctly managed and it is not as diversified as a Nifty 50 with Nifty Next 50 index, these funds will be the core part of the portfolio.
Could you give us what a good TER should be on a passive fund and if you have recommendations on which passives to choose with the Nifty 50 and Nifty Next 50?
Aditya Shah: First of all, what is tracking error is the return that the Nifty will get and the return on your passive fund, there will be a difference between both of them and that difference is known as tracking error.
Generally, what happens is that Nifty churns itself twice a year while mutual funds are not able to churn their portfolios as frequently as Nifty. So, tracking errors will arise. "How are we beating the tracking error? The funds, which have a higher AUM, they will be able to do it very easily. So, in my case, if I were to recommend two funds, we could go for the Nifty 50 index fund and the UTI Next 50 index fund.
Those funds because of their AUM and a good track record over the past five- seven-10 years. You can go for the funds that have been introduced by such as the DSP fund, but I will suggest that, or the UTI funds are the best funds since it has been coming out with this product for a longer period of time.
Amol, do you have anything to add in terms of tracking error, from the perspective of an investor making a choice between various fund options?
Amol Joshi: So, Nifty index design for that matter, any index design is more of a theoretical exercise based on the set parameter of market capitalisation, free float, etc., you can design the index. But in the actual scheme running you will essentially have to look at how the market behaves, the stock prices are moving when the market is open, the stock prices are going up and down all the time, but the NAV is declared only once at the end of the day.
So, there are various things that in real life scenario a fund manager has to manage including exceptional circumstances. We will try to quickly call both of these in one and two lines. If you get a large inflow or large outflow, that can sometimes in Nifty the problem is very less but since we are talking in general, that can also sometimes affect your buying and selling ability, or it can impact the prices of the underlying security shares. That is one aspect.
Second one I mentioned exceptional circumstances. So, we also had one of the banks going into a lock in for three years. The prices were written down at 75% and you still had to hold it for three years and at the end of three years it got liquidated and that's when the money came back. These are exceptional circumstances; these will not be reflected in the index. As I said it's a theoretical concern, but this will certainly affect a fund that works in real life environment.
Aditya, satellite allocation, obviously, this is a decision that you should take based on your risk profile, etc. How would you explain and give an idea to somebody looking to construct that portfolio today?
Aditya Shah: See, what really happens is I am very clear in my mutual fund strategy, large-cap allocation towards index funds of which is pure allocation and then you can create a satellite portfolio where you can look at the flexi-cap fund and the flexi-cap fund gives the portfolio manager enough ability to invest across market caps and the fund manager can decide whether he wants a large-cap bias or a small-cap bias or a mid-cap bias.
So that's one part of the portfolio and then depending on the risk profile, if the investor really wants to have a mid-cap or small-cap fund, depending on what is risk profile is, then you can include that. But those are the places to go for active fund management or flexi-cap fund, where the returns could be comparatively higher because the fund manager has the flexibility to invest anywhere in the market, that's one, and then the mid-cap and small-cap funds.
Would you like to give any recommendations here?
Aditya Shah: So, if you look at the flexi-cap fund companies like Parag Parekh are doing really well, or a Canara Robeco flexi-cap fund is doing really well or a DSP flexi-cap fund also doing well.
On the mid-cap and on the small-cap side, only those who are very, very highly installed to go ahead and invest those funds because the time horizon used to be 7 to 10 years, if you go ahead and invest in both types of funds.
And then again, there are there's a DSP small-cap fund and UTI small-cap fund and Nippon small-cap fund are doing well, and you can go there and invest. But the risk profile needs to be monitored and on the satellite portfolio I will dominate it with flexi-cap funds.
Amol, what is your view in terms of construction of satellite portfolio and you can also give us your fund recommendations?
Amol Joshi: So, as I mentioned after large-cap, we can certainly look at mid and small-cap dedicated allocations, so that overall, on the portfolio basis you will have that mix of 60-40 or 50-50 that kind of thing.
So, within small-cap I would like to suggest ICICI Prudential small-cap fund or a Nippon small-cap fund. Within mid-cap you can look at combination of large and mid-cap something like HDFC large and mid-cap fund. For pure mid-cap you can look at Motilal Oswal mid-cap fund as well.
Aditya, just to follow up, because you have suggested flexi cap. One of the issues that the category had was its tendency or for a large number of these funds to have an orientation towards the large-cap space. Is that a negative in your opinion?
Aditya Shah: In my opinion, if you take a look at Parag Parekh flexi-cap fund, I have known them to invest where they find value and it matches the thesis of their investment. So good flexi-cap funds will not have a bias, however it was really true that a lot of funds tend to show a large-cap bias.
Then you have to go fund by fund and they like to analyse what's really going on. In my opinion if you look at the Parag Parekh fund, they invested in I.T. schemes. Today they are investing in a company called HDFC and HDFC Bank. Nobody wants to invest in the stock price if not given information.
So, I am going more ‘why the stock,’ by the fund manager’s conviction. If they are able to stick to their conviction, they will get our performance after a certain duration of time and that's what we need to clearly monitor.
Amol, thematic and sectoral funds, what's your view on these funds and specifically the I.T. space?
Amol Joshi: In our opinion, you come to mutual funds for the simplicity that it offers, you would not want to take the burden of decision making after you choose the schemes, then for few years, you are set. If you are a person who wants to keep it safe, I would like to say that any sectoral theme or one thematic fund sector funds are best avoided.
You need to time the entry as well as exit well. I can quickly give you an example with numbers to back it up. Take the example of Nifty Pharma from 2015 to 2020, for the span of four and a half to five years, Nifty Pharma Index lost 55% and some of the stocks lost about 80 to 90% of their value and after losing 55% all these five years during the pandemic one would have thought it will do very well, it did, it rose from the bottom, it went up by about 160-170%.
But tell you what, Nifty also went up by similar percentage counted from the 23 March bottom. Now if you cannot do the consistent timing right, if you cannot get it right, entry as well as exit, sectoral funds, thematic funds are not for you.
You also mentioned specifically I.T., now we have one example of underperformance in the last phase. Take one example of outperformance, I.T., when the Nifty went up 130% from the March quarter, I.T. actually went up by 240%. But now the index is down 35% to 40% and Nifty is barely 5% to 6%.
So even at the outperformance, you do not know what the next six months have in store for you when the value drops are 40%. I would say, if you are a mutual fund investor, please stick with diversified mutual funds, need not really venture into sectoral or thematic funds.
Aditya, any quick views here?
Aditya Shah: Yes, as Amol correctly said that entering into a sectoral fund needs to be correctly timed. It is not for 99% of retail investors, they should stick to diversified funds.
However, for those 1% the investors who want to go ahead and take exposure, this is a good time to start at I.T. and pharma funds with the view that it's not make returns over the next one and a half- two years, post which can make returns for the slow and steady, which I do for those 1% investors who want to take exposure to sectoral funds, its good time for technology funds.
Vaibhav, let's talk about broader tech because I think there were a lot of expectations that built up over the course of the pandemic and that reflected in stock price movements, that seems to be unwinding to a certain extent. Would you say at this juncture that some of those expectations have been reset?
Vaibhav Dusad: I think you see a lot of growth came in technology sector across the world, including India during Covid. That was an instance then there was a sudden urgency for corporates around the world to pivot their legacy old systems something which can work remotely, and you know, in real time basis.
I think what has happened in last 12 months, there has been an increase in the interest rates, which has happened in U.S. and because of that, I think, while at the moment U.S. economy is still strong, but there have been some impacts from sentiments as well, especially after this SVB crisis.
There has been some impact in terms of sentiments in terms of spending as far as I.T. and technology is concerned. I think because of that there has been some moderation which we are facing at the moment. You have seen a couple of results already and the expectation is that in FY24 growth will be fairly moderated versus what you saw in the last two years.
That is the first one and then the second point is the growth which you have seen in the last two years, a part of that was a kind of supernormal growth. A part of that is not sustainable, I would say. So that growth, I don't expect that kind of growth to come back again and to that extent, valuations have fairly moderated from those levels.
Now, going forward, perhaps what can happen in the next two to three years, whatever growth we would be losing in FY24 in this coming year, some of that growth can come back in following years.
How will it come back?
Vaibhav Dusad: Yes, so I think the basic thing is that technology adoption, technology migration cycle, which started somewhere in 2018-19, that cycle is typically a five to seven years journey. Today, if you see we are somewhere in the middle of that cycle, cloud penetration across the world has reached 30-35%. It used to be 12-15% before Covid.
Last two years, there has been an acceleration journey, but moving towards the cloud migration and I think next two-three years the expectation is basically we could perhaps reach to 55-60-65% of cloud adoption, and I think from there on, it is more of optimal level where we may not see a significant growth from thereon.
Part of these journey is still pending and apart from that the second leg of growth, which will also emerge after some time would be development of cloud native applications. So, a lot of work is pending as far as cloud native application development work is concerned. So that would provide a second leg of growth. But that would be more of a steady state, in nature, but nevertheless, it will add certain percentage growth points in the existing industry revenues.
We have had two major I.T. companies report their earnings, how do you view both the results as well as the commentary from the management and do you anticipate that this is going to be restricted to a few companies or do you think that it's going to be something that is all pervasive, is it going to extend all the way to the small companies as well?
Vaibhav Dusad: So, I think what these companies have mentioned is some kind of demand moderation and that is more broad-based kind of stuff. There could be some company-specific issues, but they are not very clear at the moment, only when results for everyone are out, we will be able to understand better.
But at a micro level, it also depends on the kind of exposure you have in each of these verticals and within verticals in each of these sub verticals and then whether you have higher exposure in telecom, retail banking, and so on and so forth.
So, you know, performance is a function of all of those things and then the quality of the clients which you have, but as you see, I think this has happened multiple times in the past. I think generally whenever there is a sharp drop in the revenues in a particular quarter, I think in the next two to three quarters they are able to recover these revenues back.
So, I think there is not a structural challenge because of this decline, or a huge miss, which you are mentioning, and I am hopeful that gradually they would able to recover some of these lost revenues because I think structurally from a three to five years perspective the spend in tech across the world would continue and to that extent, if you look at the Indian players in I.T. players, they are very significant participatory in in this entire transformation.
I think it's largely because of how effective they have been over the years in terms of you know, right talent and right cost mix. Today, I believe that we are one of the cheapest service providers, as far as technology services are concerned around the globe. Therefore, I think, because of this entire thing, there are many more technological innovations which hopefully will come in the future. I think these companies will stay relevant and then they will again, get back onto the growth path.
What is your strategy going to be in this down year in terms of FY24, will you continue to bolster your holding in the stocks that you already have a significant holding in, or will you look to diversify?
Vaibhav Dusad: So, I think as far as technology fund is concerned, a large part of investment would continue to remain in I.T. services, depending on the macro outlook, depending on the company-specific outlook. I may change weightages from large-cap to small-cap and mid-cap and vice versa.
So, that really depends on the business outlook for one year and three-year business outlook along with the current valuations and in addition what is the quality of the management. What is the outlook on capital allocation, dividend payment, and so on and so forth.
So, I think based on these four-five parameters, I generally create my portfolio and if we are in a very bullish kind of environment, then I would aggressively focus on small and mid-caps.
In a scenario where the growth rates are declining, or it is coming off from the peak it is tepid environment then perhaps you know, we would be more towards large caps. So, portfolios would have been completely different if you would have looked the portfolio somewhere in June of 2020.
You have an allocation towards large-caps primarily or other significant allocation towards large cap.
Vaibhav Dusad: I have a large pot of money allocated in a large-cap pack.
AI as a theme, are you looking at trying to ride on that theme? Have you identified a few opportunities where you can invest?
Vaibhav Dusad: Well, I think this generative AI which you are speaking, I think, in India as such, there are no direct based. In the U.S. maybe there are few companies which are direct based on a very fundamental basis. I believe that what has changed in the last five years, see, this artificial intelligence is a very old technology, it is not new, its maybe 30-40 years in existence.
What has changed in the last five years is that first I think there is a lot of data generation which has happened. So, a lot of data creation has happened in the last few years along data collection, and you know, genetic AI use require a lot of data as their input.
The second thing that has changed is the semiconductor side of the software you compute. Your ability to compute has increased significantly in the last five years. It is a combination of these two things which is now resulting in the creation of a new interest in the form of genitive AI.
As far as exposure to genitive AI theme is concerned, again I think from our India perspective, indirect way to play would be through large-cap technology names. As far as U.S. is concerned, again, I think it would be the large-caps in U.S., you know, large enterprise software companies in U.S., which would be the direct beneficiary of this generative AI.
Essentially, I think you need three things, you need data, a huge amount of data, you need a huge amount of investments in terms of R&D, and you need a huge amount of strength in distribution and in all of these three things are available to large-cap tech in U.S.
As far as Indian I.T. services are concerned, they would participate in some of these stories, either in collaboration with large-cap tech in U.S., or directly working with some of their clients in some of these diverse sectors. So that would be an indirect way to play that.
Final call then on FY24, do you think that there is going to be a significant need for patience, and you will, as a fund manager, utilise every opportunity you have to add to your positions to buy on dips. Is that the strategy that you will take?
Vaibhav Dusad: I think I would be investor in technology on every dip because I think for me from a two-year perspective, from a three-year perspective, the story is intact.
it's just that in the near-term there is a lot of volatility when it comes to U.S. macro, European macros, and many other aspects. So, instead of timing the market, I would actually do a SIP for the next 6-12 months in technological fund and whenever there is a massive drawdown, I can do a booster SIP.
RECOMMENDED FOR YOU
JioBlackRock Launches Four New Mutual Funds — Three In Equity For First Time
Jul 16, 2025
Aditya Birla Sun Life AMC Mobilises Rs 700 Crore Through AIF
Jul 07, 2025
These Five Mutual Funds Have A 25-Year Track Record — Here's What Worked
Jun 19, 2025
Aditya Birla Capital Block Deal: Motilal Oswal, Mirae Asset, Blackrock, Edelweiss Among Buyers
Jun 11, 2025
POPULAR