Large Cap Funds: Attractive for Long-term Investors
Investing in large cap funds is a definite must for all long-term investors. Naysayers would say large cap funds do not give the high returns of say small low cap funds in high growth areas. Similarly it would be unwise to invest in large cap funds with questionable track records.
These big companies with market capitalization of over $10 billion are sometimes referred to as the ‘big Kahunas of the financial world’. Examples of large cap companies include Heinz (food), Sunoco (oil and gas), AGCO (Construction and Agriculture), Goodyear (Tires), Colgate Palmolive (Hygiene), Discovery Holding (cable), Carolina (Tobacco), Consolidated Edison (Utilities) and Sara Lee (Food processing) to name a few. Most of them are from traditional industries.
Large cap companies have lower liquidity risk. Many fund managers prefer a slightly lower rate of return if consistency and dependability are higher.
Sandeep Kothari, Equity fund manager at Fidelity Mutual fund says, "While looking at various investment options I keep the liquidity risk in mind. While I do not bucket investments in mid or large cap, if I get 30 per cent returns without taking liquidity risk and a mid-cap offers 40 per cent return I would opt for the larger cap company."
Large cap companies with higher cash reserves tend to pay higher dividends year on year, in order to keep investors, invested. They are also usually the market expanders. You will therefore find them in newer markets, which a mid-cap is unlikely to do, with lower cash reserves.
Large cap companies tend to have strong, solid balance sheets. Their basics are in place.
Large Cap funds are worth having in the kitty because they are here for the long haul. In the short run, it may seem like they are not performing as well as other high growth funds. They also get hit less harder during lows. They offer consistent dividends and many of these funds are long running. Fidelity’s Contra fund has been running since the early ‘90s.
High debt has ruined many a company. Large cap companies tend to get debt at lower rates due to their free cash flows. It is important to see the free cash flows of large cap companies. Also to be seen is its capital structure. A good way to judge this is by calculating free cash flow yield. Free cash flow yield measures free cash flow as a percentage of market cap. You may also consider replacing market cap with enterprise value while comparing companies from different industries. In general, businesses with high free cash flow and increasing shareholder equity are the stronger ones.
Large cap companies usually have a history of paying increasing dividends with each passing year. They tend to give their earnings as dividend payouts to stock holders. If you are looking at handsome, steady, long term dividends, large cap funds are the answer.
In the past few years small-cap funds have been performing better than the seemingly large, ungainly large cap funds. Large cap funds have been witnessing fund outflows to funds that specialize in emerging markets, commodities and technology. This has also been on account of investors perceiving domestic growth to be low. Resurgent domestic demand will hopefully help large cap funds re-emerge. Long cap funds are reliable, profitable and value for money in the long run. They are a definite must in every investor’s portfolio.