Large and mid cap funds: Understanding the impact of market capitalization on portfolio

When it comes to mutual funds, investors have a variety of options based on asset class, investment style, investment outcomes and more. Knowing about the different kinds of mutual funds is thus important to make the right investment decisions.

Within equity funds, investors should understand the difference between large cap, mid cap and small cap companies, and how the behaviour of each market capitalization can influence the performance and risk-return profile of a mutual fund scheme.

Read on to learn the impact of market capitalization on large and mid cap fund portfolio and investment performance.

• Table of contents

1. Market capitalization and portfolio performance
2. Impact of market capitalization on large and mid cap fund performance
3. Strategies for investing in large and mid cap funds
4. FAQs

Market capitalization and portfolio performance

Market capitalization or market cap is calculated by multiplying the total number of outstanding shares of a company with the current market price of each share. Companies are broadly categorised into large cap, mid cap and small cap based on their market capitalization.

The top 100 companies in the stock exchange are considered large cap, the next 101 to 250 are mid cap and the remaining are small cap.

Among the popular mutual fund categories are large and mid cap funds. As per SEBI guidelines, such funds must invest at least 35% of their holdings in large cap stocks and 35% in mid cap stocks.

The market capitalization of underlying stocks can significantly impact the risk and return potential of large and mid cap funds. As large cap companies are generally market leaders with established businesses, brand reputation and more transparent financials, they tend to be relatively less volatile as mid and small cap firms. Meanwhile, mid cap stocks offer the potential for higher returns than the top-tier ones as these companies are still in their growth phases but at a higher risk than large cap companies.

Impact of market capitalization on large and mid cap fund performance

So, what is the significance of market capitalization on fund performance? Here’s how it plays out in the case of large and mid cap funds:

Return potential: As mentioned earlier, mid cap stocks offer higher return potential than large caps thanks to their growing scale of operations. While this comes with relatively higher volatility in the short term, over long periods of 10-15 years, mid cap funds have historically offered superior return potential. On the other hand, large cap funds have typically offered steady returns with lower associated risks.

Volatility: Large caps have more stable businesses and inherent valuation comfort compared to mid caps. Hence, large cap portfolios witness relatively less fluctuation in their Net Asset Values (NAVs). Thus, by diversifying across market caps, large and mid cap funds can potentially achieve reasonable returns with commensurate risks.

Liquidity: Due to higher trading volumes, large caps are generally more liquid than mid caps. Large cap stocks see greater participation from foreign portfolio investments as well as local retail investors. This improves their ability to be quickly bought or sold without affecting prices significantly. Mid caps have comparatively lower trading activity.

Allocation shifts: To optimise the return potential and mitigate risks across market conditions, fund managers alter their stock selection and asset allocation between large and mid cap segments over short to medium terms. This shifts the overall risk profile and adds flexibility to capture potential opportunities across varying economic conditions.

Strategies for investing in large and mid cap funds

To reap optimal risk-adjusted return potential from investing in large and mid cap mutual fund schemes, investors need to adopt suitable investment strategies based on their goals and risk profiles. Here are some tips:

Systematic investment: You can consider opting for Systematic Investment Plans (SIPs) to benefit from rupee cost averaging and mitigate the risk of market fluctuations. This reduces the timing risk associated with investing a lumpsum amount.

Diversification: Instead of concentrating investments in a single scheme, diversify across different large and mid cap funds for potentially better performance outcomes.

Review periodically: Track fund attributes like portfolio holdings, returns, and strategy periodically and rebalance if required. Consider exiting a fund if it consistently underperforms its peers and its benchmark.

Conclusion
The market capitalization profile of underlying stocks has far-reaching implications on the behaviour and performance of equity mutual funds. Large and mid cap funds, when managed smartly with a focus on mitigating risk and increasing return potential, can emerge as suitable long-term wealth creation tools. By understanding how the market cap influences portfolio construction and planning investments accordingly, investors can generate optimal risk-adjusted return potential to achieve their financial objectives over different time horizons.

FAQs

What are large and mid cap funds?
Large and mid cap funds are mandated by SEBI to allocate at least 35% of their assets to large cap stocks and 35% to mid cap stocks. Thus, these schemes seek to leverage the relative stability of large caps and the growth potential of mid caps.

What are some red flags investors should watch out for in large and mid cap funds?
Some red flags to watch out for include consistent underperformance against peers and the fund’s benchmark over longer periods, high portfolio concentration in select stocks, and sudden changes in fund manager or investment style.

How are large and mid cap funds managed?
Large and mid cap funds are actively managed by professional fund managers who make investment decisions based on thorough research, market analysis, and the fund's investment objectives.

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.