Understanding Mutual Funds Across Market Capitalisation
If you’ve seen mutual fund advertisements, odds are you’ve come across the terms large-cap funds, mid-cap funds and small cap funds. In this context, the word ‘cap’ refers to the market capitalisation, or the size, of a listed company. As you will learn in this article, a company’s size is an important criterion for mutual funds, when picking stocks for equity portfolios. This is because investing in a company of a certain size brings with it unique opportunities and risks – the advantages and drawbacks of large-cap fund investment are different from that of a small-cap fund investment. Normally the definition of Large cap, Midcap and small cap are provided in the Scheme Information Documents
of respective Scheme. Read on to get a clear picture.
Large cap funds
Large cap funds are those funds which invest a larger proportion of their corpus in companies with large market capitalization. Trustworthy, reputable and strong are three adjectives that are often used to describe a large-cap company. These are the old and well-established players with a track record. Such companies typically have strong corporate-governance practices, and have generated wealth for their investors slowly and steadily over a long term. These corporate houses are usually among the most highly followed and well-researched on the market. Mutual funds that invest a majority of their investible corpus in these companies are labeled as large-cap funds.
Being seasoned players, the underlying companies in the portfolio of large-cap funds may be considered as relatively steady compounders and regular dividend payers. On the risk-return spectrum, large-cap funds deliver steady returns with relatively lower risk, compared with mid- and small-cap funds. They are ideal for investors with lower risk appetite. So, adopt a long-term perspective, stay patient, and remain invested to reap good returns over the long term.
As can be seen in the graph below, large-cap funds have given better returns over a long term..
Chart 1: Daily average rolling returns since inception - CRISIL-AMFI Large-cap, mid-cap and small cap fund performance indices
Source: Crisil Research
Mid-caps are those that they lie between large-caps and small-caps in terms of company size. During a bull phase, mid-cap stocks may outperform their large-cap counterparts, as these companies seek to expand by looking out for suitable growth opportunities. Investors should, however, note that the underlying stocks are more volatile than their large-cap counterparts. Mutual funds that mainly invest in mid-cap entities are labeled mid-cap funds. Through prudent stock selection, diversification across sectors, and market timing, fund managers aim for better returns.
Mid-cap equity funds are advised for investors with a higher risk tolerance than large-cap investors. So, invest in these schemes if you seek higher capital appreciation, albeit with reasonably higher risk.
Small caps funds
Small-cap stocks typically have the highest growth potential, since the underlying companies are young, and seek to expand aggressively. They are more vulnerable to a business or economic downturn, making them more volatile than large and mid-caps. Investors who are keen to invest in the small-cap space and may not have the time to research but possess the high risk-taking capacity can look to invest in small cap funds.
Small- and mid-cap funds typically outperform large-caps during a bull market (Chart 2), but decline more when the sentiment turns bearish. The choice of a right fund should be in line with the risk appetite, return expectations and investment horizon of the investor.
Chart 2: Market-phase performance of large-, mid- and small-cap funds
Source: Crisil Research
Investment in the large, small and mid-cap funds can also be done via Systematic-Investment Plan (SIP), wherein a fixed sum is invested in funds at regular intervals, which averages out the cost – buy more units when the net asset value (NAV) falls and less when the NAV rises – thereby reducing the volatility across market cycles.
Any information contained in this article is only for informational purpose and does not constitute advice or offer to sell/purchase units of the schemes of SBI Mutual Fund. Information and content herein has been provided by CRISIL Research, a Division of CRISIL Limited, and is to be read from an investment awareness and education perspective only. The views / content expressed herein do not constitute the opinions of SBI Mutual Fund or recommendation of any course of action to be followed by the reader. Investors should consult their financial advisers before taking any investment decision.
Mutual Fund investments are subject to market risks, read all scheme related document carefully.