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By MOFSL
2025-01-24T06:12:38.000Z
6 mins read
How to choose between Large Cap Funds and Index Funds?
motilal-oswal:tags/mutual-fund-account,motilal-oswal:tags/mutual-fund,motilal-oswal:tags/sip,motilal-oswal:tags/mutual-fund-investment
2025-01-24T06:12:38.000Z

Large Cap vs. Index Funds

As of 2025, investments are a vast field with options available for investors from different demographics. Mutual funds are an easily accessible form of investment. Within mutual funds, there are multiple types of funds you can choose from. The two most prominent types are large-cap funds and index funds.

In this blog, let's decode these two mutual fund types and understand the differences between large-cap and index funds.

What Are Large Cap Funds?

Large-cap funds are a type of equity mutual fund that invests mainly in shares of big companies. These are usually among the top 100 companies as per market value. These are considered more stable investments compared to smaller companies.

Professional fund managers handle these funds by collecting money from investors and buying shares of various large companies in different industries. Before investing, they study the company’s financial situation, leadership, market trends, and the overall economy to make sure they are making sound investment choices.

What Are Index Funds?

Index funds are mutual funds created to replicate the performance of a specific market index like the SENSEX. They aim to achieve the index’s returns and reduce any tracking differences.

These funds can focus on different segments of the market, like large-cap stocks or specific industries. By investing in an index fund, you get a diverse mix of stocks without relying on a manager to select them and yet they provide a broad market exposure with less effort.

Difference between Large-Cap Funds and Index Funds

Here is a comparison that shows the differences between large-cap funds  and index funds:

Investment Consideration
Large-Cap Funds
Index Funds
Investment Portfolio
Fund managers actively select sectors and individual stocks from the top 100 large-cap companies. They aim to outperform the market by investing primarily in large-cap firms.
It is a passive strategy. Fund managers strictly follow the composition of a specific market index. They do not have the flexibility to choose individual stocks or sectors. They just make sure that the fund mirrors the index’s structure by tracking its changes.
Generation of Alpha
Managers can select outperforming stocks and can exceed the benchmark index by generating alpha for investors.
Returns closely match the underlying index and have limited to tracking errors and fund expenses. There is no intention to outperform the index, so alpha generation is non-existent.
Popularity and Investment Data
As of February 2020, large-cap funds were the second most popular equity category with 98 lakh investor folios and an AUM of Rs 1.46 lakh crore.
Index funds had around 5 lakh investor folios with an AUM of Rs 8,000 crore as of February 2020. They are less favored compared to large-cap funds.
Unsystematic Risk
Active management exposes investors to risks from bad stock selection or sector allocation, which can lead to losses if the manager makes poor investment choices.
Passive investing reduces the impact of individual stock or sector performance.
Expense Ratio
Active management requires more research and decision-making resulting in higher management fees and expense ratios compared to passive funds.
Minimal management involvement and lower management fees and expense ratios.

How to Choose the Best Index Fund?

When selecting an index fund, the most important factor to consider is the tracking error. Opt for a fund with the lowest tracking error to ensure it closely follows the performance of the benchmark index. High tracking errors mean that the benefits of index investing can deviate from the index.

Large-cap funds have the potential to deliver higher returns than the overall market. Skilled fund managers can generate additional profits (alpha) for investors through strategic stock selection.​​​​​​​

Both index funds and large-cap funds are subject to the same tax regulations, except for debt index funds, meaning there are no tax advantages unique to either option. Choosing between them depends on individual financial goals, risk tolerance, and investment timeline.

Conclusion

There is no one-size-fits-all rule for choosing the right fund. Investors should evaluate the differences between index and large-cap funds in the context of their personal financial objectives, risk preferences, and investment duration to make an informed decision.

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