Investors should always remember that portfolio risk management is as essential as striving to meet the return objective. There are more than 5000 stocks listed in the Indian stock market. It is a huge collection of a lot of microcaps, a few smallcaps, some more midcaps and a handful of largecaps.
Currently, there are a lot of investors who might be thinking that there is no evident benefit of investing in largecap stocks as the smallcap and midcap stocks are hitting through the roof and becoming multibaggers by giving double or even triple digit returns in a span of months.
In this kind of return environment, it is very important to understand and recall the concept of volatility. Smallcaps and midcaps have comparatively much higher volatility against largecaps. If there is a black swan event in the world such as a war or a global epidemic, the largecaps will be the one to balance out investorsтАЩ losses in other stocks during market fall.
Additionally, there are a lot of global pension funds and large institutional investors which hold largecap stocks just for getting a regular cash flow stream in the form of dividend income. In fact, as the standard deviation in these stocks is relatively much lesser, it saves the investor from large capital losses during instances of market turbulence.
Despite modest growth on a yearly basis, the L&T and TCS of the stock market have been exceptional compounding stories as the Indian economy rose to periods of super strong economic growth, higher corporate earnings growth in a declining interest rate environment.
On the other hand, if one looks into smallcap stocks,say for example Brightcom Group there are a series of days where the stock went through lower circuit/upper circuit patterns bringing in more stress on any investorsтАЩ mindset. Additionally, there is a big issue in terms of low liquidity when it comes to smallcap stocks.
If the risk profile of an investor is about getting stable returns, then there is no better choice than largecaps. In fact, the investors can further cut down on their volatility risk by investing in index funds. These are mutual fund schemes in which the investment is in the top 50 companies by market cap regarded as largecaps. The role of a fund manager is largely passive here and the portfolio churn cost is limited.
However, if an investor seeks higher growth with some amount of stability to his/her portfolio, then one should go for a mix of both smallcap/midcap and largecap stocks. The portfolio allocation of these types would certainly depend on the individual investor risk appetite.