In our previous posts we have always said that investing in mutual funds is the best way of diversification and the best choice for 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, is where investors invest in getting exposure to equity, allowing investors to earn corresponding capital gains. Equity mutual funds are further sub-categorised based on their market capitalisation, which are large cap, mid cap and small cap. Before we get into more details, let’s clear the basic concept of market capitalisation and understand large cap, mid cap, and small cap.
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Defining Market Capitalisation
Market capitalisation 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 capitalisation:
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 ₹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 capitalisation of XYZ company is 10,00,000.
As mentioned above, based on the market capitalisation, 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 capitalisation.
- Mid cap: Companies ranked between 101 and 250, when sorted by market capitalisation.
- Small cap: Companies ranked beyond 250, when sorted by market capitalisation.
It is important to remember that market capitalisation keeps fluctuating because the share 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.
Defining 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 capitalisation 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.
- They have a strong market positioning, as they are known to exhibit strong growth with high profits.
- 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.
Defining 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 capitalisation 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.
Defining 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 capitalisation.
- 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
Risks
- 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.
Returns on Investments
- 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 investors with a long term investment horizon and who do not wish for aggressive returns.
- 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.
- Small cap funds are suitable for investors with higher risk tolerance levels and are very aggressive.
Conclusion
Understanding market capitalisation can play a significant role in one’s investment diversification strategies. When large caps in one’s 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 one’s portfolio could steady the overall returns. So, it is important for stock and mutual fund investors to diversify their portfolios by investing across market caps. It will help one’s portfolio to tide one over changing market conditions. One should just make sure to factor in the financial goals, appetite for risk, and investment horizon before investing. Investing in the share market or mutual funds requires research and analysis. For further assistance or information, feel free to contact Share India and stay updated with our website, social media, and research papers for valuable insights on the Indian stock markets.
