Why large-cap funds are losing their alpha edge post-2010: Key factors behind decline and what investors should do

Active large-cap mutual funds are designed to give fund managers the flexibility to generate “alpha” returns above the benchmark index through stock selection and portfolio management strategies.

However, over the years, the gap between large-cap funds and the Nifty 50 TRI has narrowed, raising questions about the category’s ability to consistently outperform its benchmark.

So, let’s look at the performance of large-cap funds, along with expert views on the changing alpha landscape.

Strong outperformance in the 2000-2009 phase

From 2000 to 2009, large-cap funds delivered notable outperformance compared with the Nifty 50 TRI.

Over three-year daily rolling returns, large-cap funds generated an average return of 25.8%, compared with 21.3% for the Nifty 50 TRI, resulting in an alpha of 4.5%.

Similarly, over five-year daily rolling returns, large-cap funds delivered 28.5% returns against 23.6% for the index, generating an alpha of 4.9%.

Alpha narrowed between 2010 and 2019

The advantage of active large-cap funds narrowed during the next decade. While funds continued to outperform the Nifty 50 TRI between 2010 and 2019, the margin of outperformance declined significantly, with alpha falling to around 1%.

Large-cap funds lagged the index after 2020

The trend reversed after 2020, with large-cap funds failing to outperform the Nifty 50 TRI.

For three-year daily rolling returns, large-cap funds delivered 13.8%, compared with 14.4% from the Nifty 50 TRI, resulting in a negative alpha of 0.6%.

Over five-year rolling returns, the gap widened further, with large-cap funds delivering 12.8% compared with 14.1% from the index, leading to a negative alpha of 1.3%.

Why is alpha declining in large-cap funds?

Subhendu Harichandan, Executive Director, Anand Rathi Wealth Limited, said the decline in alpha generation by large-cap funds is largely due to a narrower investment universe, making it more difficult for fund managers to outperform the benchmark.

“SEBI mandates that large-cap funds invest at least 80% of their portfolio in the top 100 companies by market capitalisation, significantly limiting the investable universe,” Harichandan said.

This has increased portfolio overlap with benchmark indices such as the Nifty 50, reducing the flexibility available to fund managers to take meaningful active bets.

According to him, the average active weight of large-cap funds compared with the Nifty 50 is only around 30% to 40%, meaning a significant portion of these portfolios remains similar to the benchmark.

“Only a handful of funds, such as Quant Large Cap Fund, maintain active weights of 60% to 70%, making fund selection an important factor within the category,” he added.

What should investors consider now?

Harichandan said investors should not assume that large-cap exposure can only be achieved through large-cap funds.

“Diversified categories such as flexi-cap and focused funds often maintain 60% to 70% allocation to large-cap stocks while retaining the flexibility to invest across market capitalisations and alpha generation,” he said.

He added that instead of evaluating large-cap funds in isolation, investors should assess their overall equity portfolio allocation.

“A balanced market-cap mix of around 50% to 55% in large caps, 20% to 25% in mid caps, and the remaining allocation in small caps can provide adequate large-cap exposure while improving the potential for better risk-adjusted returns,” he concluded.