All the light you cannot see. The title of the recently launched and brilliantly crafted Netflix series has a lesson for those who have lately stayed away from large caps, focusing almost exclusively on the mid and small cap spaces instead. Now that sentiments are significantly tetchy on both fronts, the time for large caps has arrived. And investors may now need to rejig their allocations in favour of large caps yet again.

Consider recent movements in smaller, medium-sized stocks across sectors. Their valuations have advanced markedly, prompting an influential section of investors to take home profits. At the same time, a number of stocks with large market capitalisations have remained relatively sluggish in comparison during this period.

Many investors have tended to avoid these, or have assumed neutral positions, insofar as their allocations are concerned. The situation has disbalanced portfolios — there is excessive exposure to small and mid caps at this juncture.

Large caps, however, are expected to deserve a fairer treatment. Investors, both big and small, may well rectify the anomaly in order to balance the scales more effectively. In short, a heavier emphasis on large caps is said to be the need of the hour.

Rationale

Why are large caps necessary? Why can’t portfolios be entirely made up of other kinds of stocks? These questions are easy to answer — large caps, after all, are said to add stability to portfolios. These stocks are pursued by all manners of investors; liquidity is rarely a problem. Many large caps, especially those that constitute the major indices, command significant trading volumes.

With reference to indices (say, the 50-share Nifty, the primary indicator managed by National Stock Exchange), large caps are the strongest stocks in the market. The companies they represent are the darlings of the corporate sector. Can we imagine Corporate India without the presence of Reliance, HDFC Bank, Infosys or ITC? I mention these names (the “mega caps”, to categorise the toppers) as mere examples. Needless to say, these appear in leading indices like Nifty and Sensex.

The equity market, it may be argued, stands on the shoulders of these giants. Large caps, technically the first hundred companies in the market cap rankings, are chased by institutional money. This trend often helps in sustaining their valuations. Taken together, large caps spell stability and growth.

Growth

Yes, the other major affirmative factor is the probability of growth. Large caps are considered critical for investors who aim at long-term wealth. This often encourages them to hold such stocks across multiple market cycles. Investors have in the past gained handsomely from such buy-and-hold strategy. The more perceptive ones will continue doing so in the future as well.

How have large cap indices moved in the recent past? I will refer to the figures supplied by NSE here. The Nifty, which today (as on November 15, 2023) stands at 19675.45 points, stood at 18329.15 points exactly a year ago. Its 52-week high was 16828.35 points. This spells good news for index watchers in general. It indicates, inter alia, the latent strength of the popular benchmark.

In this context, two points are worth mentioning:

1. Not all large caps have moved as effortlessly as the biggest gainers

2. There is, it is said, still considerable scope for re-rating in some sectors. Large caps from these sectors will be among the clear winners

Strategies

Investors who have limited exposure to large caps may explore the possibility of changing their allocation patterns. In this context, I will specify a few key points.

1. It is difficult to say how much should be allowed for large caps. However, conservative estimates often underline the belief that a third of an investor’s portfolio should be dedicated to these stocks.
2. There can never be a hard and fast rule. It is not for us to suggest whether you should keep 30 per cent for large caps or whether 60 per cent is a safe bet.
   
3. Allocation should be a factor of your risk profile. An aggressive investor will look for smart alternatives at all times.
   
4. A pack of large caps comprising the best-known or the heaviest counters will not hurt anyone. It is easy to hold a diversified portfolio of popular stocks picked up from the list of the first hundred names.
   
5. If you do not wish to invest directly in stocks, there are large cap funds to support you. A professional fund manager will place his expertise on the table. Buy in bulk and follow it up by investing systematically.
   
6. If you want to narrow it down further, pick up index funds tracking the Nifty or the Sensex. An index fund aims at mirroring the chosen index faithfully. It does not intend to outperform the benchmark. Countless investors from across the world bet on index funds. In India too, a sizeable section of the market has lately turned to such funds. Indexing is very much part of their core strategy at the moment.
   

As I observed at the very beginning, All the light you cannot see has lessons for our investors. The story of a blind girl, set in France during the Second World War, shakes us out of our stupor. It prompts us to be vigilant and ask fundamental questions. As investors, we too must re-evaluate some of our current allocation strategies, especially when it comes to large caps.

The writer is director of Wishlist Capital Advisors