Small, mid, and large cap funds: What they are and how to choose

Equity-oriented mutual funds invest in the stocks of listed companies and offer the potential for significant capital appreciation over the long term. However, within equity funds, there are many sub-types of mutual funds focusing on different segments of the market. For example, large cap, mid cap, and small cap funds each represent a category of equity funds offering unique characteristics, return potential, and associated risks.

Many investors may get lost in the large cap vs small cap and large cap vs mid cap debate. In this article, we will compare small, mid, and large cap funds in India.

• Table of contents

1. Large cap vs mid cap vs small cap funds
2. Asset allocation
3. Return and risk potential
4. FAQs

Large cap vs mid cap vs small cap funds

• Large cap funds: Primarily invest in stocks of companies ranked from 1 to 100 based on market capitalisation. These are well-established entities with a track record of stable and long term performance.
• Mid cap funds: Invest chiefly in stocks of companies ranked from 101 to 250 based on market capitalisation. These funds may have a relatively higher growth potential as their strategy is to invest in high-performing companies that have the potential to become large cap companies in the future.
• Small cap funds: Invest mainly in stocks of companies ranked 251 and beyond based on market capitalisation. These companies are newer and have the potential for rapid growth, though their future might be uncertain and hence prone to more volatility.

Asset allocation

• Large cap funds: These funds have to allocate at least 80% of their portfolio to large cap stocks. The remaining portion may be allocated to smaller companies or cash equivalents for diversification and liquidity purposes.
• Mid cap funds: The funds need to maintain a minimum 65% portfolio allocation to mid cap stocks. The remaining portion may be invested in large cap stocks or small cap stocks to manage risk and enhance diversification.
• Small cap funds: Mandated by SEBI to invest a minimum of 65% of their assets in small cap stocks. They may hold a small portion in mid cap or large cap stocks to mitigate risk and enhance portfolio stability.

Return and risk potential

• Large cap funds: Large cap funds offer a relatively lower return potential compared to mid cap and small cap funds as they invest in well-established companies that may grow at a slower pace than smaller establishments. However, these funds aim to provide the potential for steady capital appreciation with relatively lower volatility over the long term. Thus, they can suit investors who are comfortable with taking some risk but prioritise steady growth over very high risk and very high return investment opportunities.
• Mid cap funds: Have the potential to deliver relatively higher returns compared to large cap funds because they invest in companies that are still in the growth phase. However, the accompanying risks are also higher. They are more sensitive to market movements and economic conditions than large cap funds and more prone to fluctuations. They are suitable for investors with a high risk appetite and a longer investment horizon.
• Small cap funds: They have the highest return potential as well as the highest risk among the three categories. They are highly susceptible to market downturns, economic uncertainties, and company-specific risks, so volatility in the portfolio value and fluctuations can be high. They are suitable for aggressive investors with very high risk tolerance and investment horizons.

Conclusion

Small, mid and large cap funds cater to investors with varying risk appetites, investment horizons, and return expectations. While large cap funds offer relative stability, mid cap and small cap funds provide higher growth potential but with higher volatility. Investors should align their investment choices with their financial goals, risk tolerance, and investment horizon to build a well-diversified portfolio that can potentially help them meet their goals. It is always recommended to consult a financial advisor to make informed decisions suited to an investor’s circumstances and goals.

FAQs:

Are large cap funds stable investments?

Large cap funds invest in the stocks of market leaders and well-established companies with proven track records. While these funds are relatively stable compared to mid cap or small cap funds, they still carry the market risks associated with equity investments.

Who should invest in small cap funds?
Small cap funds offer the potential for high returns but at a very high associated risk. Aggressive investors with a very high risk appetite and long time horizon may consider allocating a part of their portfolio to small cap funds.

What is the main feature of mid cap funds?
Mid cap funds seek to strike a balance between the relatively stability of large cap funds and the growth potential of small cap funds.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.