In our previous posts we have always said that investing in mutual funds is the best way of diversification and the best choice as a beginner, but beginners beginning their journey with mutual funds have many questions about where to invest.
One subcategory of mutual funds i.e., equity mutual funds, where investors invest in getting exposure in equity, allowing investors to earn corresponding capital gains. Equity mutual funds are further subcategorized based on their market capitalization, which are large cap, mid cap and small cap. Before we get into more details, let’s clear the basic concept of market capitalization and understand large cap vs mid cap vs small cap.
What is Market Capitalization?
Market capitalization can be defined as the total value of the company that is traded on the stock market. It is calculated by multiplying the total number of shares by the current market per share price. The following is the formula for market capitalization:
Market capitalization = Total number of outstanding shares of the company * Current market price per share.
For example – if the current market price of XYZ company is Rs.10 and the total number of outstanding shares of the company is 100,000.
Then, market cap = 100,000*10 = 10,00,000
Therefore the market capitalization of XYZ company is 10,00,000.
As mentioned above, based on the market capitalization, the companies registered with SEBI are classified as large cap, mid cap and small cap, following a uniform pattern. As per the SEBI guidelines the companies are classified as:
Large-cap – companies ranked between 1 and 100, when sorted by market capitalization.
Mid-cap – companies ranked between 101 and 250, when sorted by market capitalization.
Small-cap – companies ranked beyond 250, when sorted by market capitalization.
Note: The market capitalization keeps fluctuating because the shares prices keep fluctuating. When a company issues more shares to the public, its market cap increases, and on the other hand when a company buys its shares back, the market cap decreases.
What are Large Cap Mutual Funds?
Large cap mutual funds are open-ended equity mutual funds that invest a significant portion i.e., at least 80% of their investments typically in companies having a market capitalization of more than thousands of crore. These companies usually tend to be the market leaders in their specific industrial sectors and thus likely also demonstrate an excellent past track record of wealth generation. Also, they have a strong market positioning, as they are known to exhibit strong growth with high profits. Furthermore, investors can enjoy better capital appreciation, steady compounding, and regular dividends from these companies. Large cap funds are lower-risk in comparison to small-cap or mid-cap funds. Hence, investors can benefit from steady returns of these funds if they have a low-risk appetite. Consequently, the investment horizon of these schemes is long-term.
What are Mid Cap Mutual Funds?
Mid cap mutual funds are open-ended equity mutual funds that invest at least 65% of their investments in mid cap company stocks. Mid cap stocks are those companies that rank 101st to 250th in terms of market capitalization values. Mid cap companies have a good track record and have the potential to grow into large cap companies. However, there can also be chances of downfall.
Midcap mutual funds try to strike a balance between risk and return. Owning to the nature of investment in growth stage companies, these funds may have higher growth potential than large cap funds. While they are highly sensitive to market conditions, they are also less riskier than small cap funds.. Investors are suggested to stay invested for long horizons in these funds to protect themselves from these market fluctuations. This will help investors overcome the effect of market fluctuations on their investments.
What are Small Cap Mutual Funds?
Small cap mutual funds are open-ended equity mutual funds that invest at least 65% of their investments in small cap stocks. Small cap stocks are those companies that rank below 250th in terms of market capitalization. These are small companies that are new entrants in the market.
Small cap funds are highly volatile in nature and involve a high level of risk. Usually, even slight volatility in the market environment impacts the share prices of small cap companies immediately. However, these funds also offer a very high return potential to investors as the company grows. Usually, small companies need time to grow. Hence, one may opt for small-cap funds depending on their risk tolerance level and investment horizon. Ideally, risk appetite should be higher for small cap funds, and investment tenure must be longer.
Large Cap Funds vs Mid Cap Funds vs Small Cap Funds:
- Large cap funds invest in large cap companies with a good reputation and excellent track record in the stock market. Also, they have a significant market share and consistent performance. Thus, this makes them less risky than mid cap and small cap stocks. eg, companies in Nifty 50
- Mid cap funds invest in mid cap companies with relatively higher risk than the large cap companies but lower than small cap companies.
- Small cap funds invest in small cap companies that are riskiest amongst the three, and thus tend to have a higher fluctuation in market prices which in turn increases the risk for investors.
- Large cap funds provide stable and steady returns with low volatility.
- Mid cap funds can offer higher returns than large cap funds as the growth potential is more.
- Small cap funds can offer higher returns than large and mid cap funds, due to great potential for growth. However, they are more volatile due to their nature and company size.
- Investment Goals:
Investors should always make a well-informed decision for building a portfolio keeping the risk and return in hand. Large cap funds are suitable for investors with lower risk tolerance. These investors look for investment opportunities in the equity market and prefer large cap schemes. Large Cap funds are for the investors with a long term investment horizon and who do not wish for aggressive returns.
At the same time, investors with moderate risk tolerance levels can prefer mid cap funds. These investors are not affected by the short term volatility as they prefer investing for the long term. Subsequently, small cap funds are suitable for investors with higher risk tolerance levels and are very aggressive.
Understanding market capitalisation can play a significant role in your investment diversification strategies. When large-caps in your portfolio are not doing so well, it could be that mid- and small-caps could be on the rise. And when mid- or small-caps are on their lows, the large-caps in your portfolio could steady your overall returns. So, it is important for stock and mutual fund investors to diversify their portfolio by investing across market caps. It will help your portfolio to tide you over changing market conditions.
Just make sure to factor in your financial goals, appetite for risk, and investment horizon before investing. Investing in the share market or in mutual funds requires research and analysis. If you need more knowledge or support, do not hesitate to reach out to your ShareIndia Account Manager, and keep checking our website, social media and research papers for a wide range and depth of actionable insights on the Indian stock markets.