EspressoLogy

2022 has not been a good year for the world's stock markets. The S&P 500 is down 21% since the beginning of the year, its worst first half since 1970. Reasons for the same can be attributed to many reasons, such as:

- Russia vs Ukraine war

- Highest inflation rate world over

- Multiple rate hikes by the Federal Reserve to combat inflation

- Overall overheating of markets post lockdowns

Hence, in such trying times, the focus of an investor shifts from that of generating returns to that of preserving her capital. Any loss less than the benchmark indices is counted as a job well done, with a gain (however unlikely), a bonus.

So, where does one invest in such a market? Historically, it is noted that largecaps are a much safer bet than mid & smallcaps during uncertain periods in the market.

Here is why:

An element of trust:

Largecap stocks are big brand companies which have grown their brands over the years and have an element of trust attached to their names. Customers rely on their products for everyday use, which directly affects their perception of the stock market and their stock price. This is why largecap stocks are treated as "safe haven" investments, with the underlying assumption that these companies are here to stay long-term.

Higher liquidity:

Largecap stocks are more liquid than others, which means they are more readily available to purchase and sell at a fair market price. This prevents their prices from being subjected to significant fluctuation which helps in a falling market scenario.

Dividend-paying:

Most largecap companies tend to pay out a good dividend to their shareholders yearly, if their options to reinvest profits are limited. This benefits shareholders as it forms a source of passive income while effectively reducing their average cost of each share purchased.

Greater ability to absorb higher costs:

In such inflationary times, there are huge cost pressures on businesses to ensure profitability. Largecap companies, due to their sheer size and scale, can absorb these higher costs to still ensure profitability for shareholders. Smaller companies, however, cannot do so, which tends to affect their profitability and stock price directly.

First pick of large institutions and mutual funds:

Most large institutions and mutual funds have strict guidelines on the kind of investments they are allowed to make, with largecap stocks being their investments of choice. As soon as the market picks up again, a large portion of the liquidity is driven straight to these stocks, which ends up giving good returns for the investors who got in earlier.

Foreign exchange income: 

With rising interest rates worldwide, the rupee tends to devalue as compared to the dollar due to the sheer demand for USD. This tends to benefit companies with high export revenues, which most largecap companies tend to have (eg IT sector). This is likely to increase their profitability in the near term, as compared to their small and midcap peers, and make them more investible in the long term.

Due to these attributes, largecaps tend to be a lot less volatile as compared to their mid and smallcap peers when measured by metrics such as beta and standard deviation. While this means that they will outperform in falling markets (fall less than the average), they are likely to underperform (rise less than the average) in rising markets.

In a nutshell, one must look to invest in largecaps due to the limited amount of selling pressure during times of fall and the first preference of large institutions as liquidity returns to the markets. Over time, it has been proven that largecap stocks tend to provide returns which are comparable to midcaps & smallcaps while having a lower risk profile. Isn't that what every investor wishes for – higher return for lower risk?

Disclaimer: Investment in securities market are subject to market risks. Read all the related documents carefully before investing. Please refer the Risk Disclosure Document issued by SEBI and go through the Rights and Obligations and Do’s and Dont’s issued by Stock Exchanges and Depositories before trading on the Stock Exchanges. Brokerage will not exceed the Exchange prescribed limit.