Understanding Large Cap, Mid Cap & Small Cap Funds: A Comprehensive Guide

What is the difference between Large Cap, Mid Cap, and Small Cap Funds?

Equity Mutual Funds can be categorized based on the market capitalization of the companies they invest in. They can be classified into three types – large-cap, mid-cap, and small-cap funds. In this article, we will look at understanding these funds and talk about the difference between small-cap, large cap and mid cap funds.

But first, some basics:

What is Market Capitalization?

Market Capitalization, in simple words, is the market value of the company’s outstanding shares. It is not the share price but the value of the share. Before we explain further, here is a question for you:

The share price of Company A is Rs.25 and that of Company B is Rs.60. Which company has more value? Which company will be more stable?

The answer to this question is not easy since the information provided is limited.

Now, if we say that Company A has 500,000 shares in the market and Company B has 100,000 shares in the market, then which company has more value?

This makes more sense now. So, the total value of the outstanding shares of both companies is:

• Company A – 500,000 x 25 = Rs.1.25 crore
• Company B – 100,000 x 60 = Rs.60 lakh

Hence, Company A has a higher market value than Company B. This is market capitalization or market cap. The formula to calculate it is: 

Number of outstanding shares x share price

Based on the market cap, companies are classified as large-cap companies, mid-cap companies, and small-cap companies. In order to ensure that equity schemes follow uniform norms for defining large, mid, and small caps, the Securities and Exchanges Board of India (SEBI) has defined them as follows:

• Large-cap companies – 1st to 100th company in terms of market capitalization
• Mid-cap companies – 101st to 250th company in terms of market capitalization
• Small-cap companies – 251st company onwards in terms of market capitalization

It is important to note that since the share price keeps fluctuating, the market cap of a company keeps changing too. Also, when a company issues more shares to the public, it’s market capitalization increases. On the other hand, in the case of a buyback, the market cap dips. Having understood, market cap, let’s look at large, mid, and small-cap funds.

What are Large-Cap, Mid-Cap, and Small-Cap Funds?

Large Cap funds are open-ended, equity funds which invest at least 80% of their total assets in large-cap stocks. Large-cap companies are trustworthy and strong companies with an excellent track record. They are known to have generated wealth for their investors.

Mid-cap funds are open-ended, equity funds which invest around 65% of their total assets in equity and equity-related instruments of mid-cap companies. These companies have been around for quite some time and have a good track record too. Some of these will soon transform into large-cap companies. This makes the mid-cap segment an interesting one for growth opportunities with controlled risks.

Small-cap funds are open-ended equity funds which invest a minimum of 65% of their total assets in small-cap stocks. These are the smaller companies or the new entrants in the market. These funds have a high potential for growth but also carry a high amount of risk. They are usually recommended for investors with higher risk tolerance.

Difference between Large-Cap, Mid-Cap, and Small-Cap Funds

Here are some key differences between large-cap, mid-cap, and small-cap funds.

Risk Profile Large-Cap Funds These funds are considered to be the least risky among the three since they invest in stocks of the top 100 companies. Typically, you can think of the companies in the NIFTY 50. Mid-Cap Funds These funds are riskier than large-cap funds but less risky than small-cap funds.  Small-Cap Funds These funds are the riskiest of the three. Small-cap companies have a low capital base. Despite the risks, these stocks offer great potential for growth.

 

Returns Large-Cap Funds These schemes tend to offer steady returns with lower volatility. The average returns are 7% in the last five years. Mid-Cap Funds These schemes offer better returns than large-cap funds. The average 5-year returns are 10.28%. Small-Cap Funds Being the highest-risk schemes, they tend to offer an opportunity to earn good returns. The 5-year average has been 14.72%.

 

Role of the Fund Manager Large-Cap Funds Since these funds primarily invest in large-cap stocks, the fund manager needs to choose stocks based on the investment objective of the scheme. The information of these companies is easily available and their returns are usually stable. Hence, the fund manager needs to focus more on the right stock selection. Mid-Cap Funds The information about the companies in the mid-cap space is not very easy to come by. Hence, the fund manager needs to research the companies well before investing. Also, come mid-cap companies are on the verge of growing big. The fund manager needs to identify these opportunities and make adjustments to the portfolio accordingly. Small-Cap Funds Investing in small-cap stocks requires a fund manager with experience in analyzing the small-cap sector. These companies are highly volatile and tend to rise or fall sharply within days. Hence, the fund manager needs to be in sync with the market at all times.

 

Who should invest in them? Large-Cap Funds Investors with a lower risk tolerance looking for investment opportunities in the equity markets usually prefer these schemes. You need to have a long-term investment horizon. Also, it is suited for investors who are not seeking aggressive returns. Mid-Cap Funds Investors with medium risk tolerance and seeking exposure to the equity markets prefer these schemes. You need a long-term investment horizon and be comfortable with around 10% returns. Small-Cap Funds These schemes are for aggressive investors with higher risk tolerance. Since the small-cap space is highly volatile, these schemes are for investors who can stomach the volatility. In the long-term, you can expect good returns. You must research the fund manager well before investing in a small-cap fund

 

Summing Up

As you can see above, large-cap, mid-cap, and small-cap funds are designed to meet the requirements of different types of investors. Before investing, ensure that you understand your investment needs and invest according to a financial plan.

Disclaimer : This content has been contributed by Nippon India Mutual Fund (erstwhile Reliance Mutual Fund).