Understanding Mutual Funds .... Across Market capitalization

Understanding Mutual Funds .... Across Market 

capitalization

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-cap funds

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.

Summing up

Happy investing

Source: SBIMutualfund.com