With India’s equity market on a bull run, you must be eager to take that plunge. That said, investing directly in stocks requires expertise and vast knowledge. In case you are new to the investing world, allocating funds to equity mutual funds can be an ideal alternative. Now, with regard to the market capitalisation of the underlying stocks in a fund’s portfolio, there are three categories of equity funds. These are small cap, mid cap and large cap funds.
Here, we’ll be covering all details regarding these mutual fund schemes, including their meaning, benefits and differences.
As per SEBI, these open-ended funds invest at least 65% of their total assets in equity shares of companies ranking 251st onwards with respect to market capitalisation. Small-cap firms are younger in the industry and smaller in size when compared to mid-cap and large-cap companies.
These companies have tremendous growth potential but at the same time, they are severely impacted during economic downturns. Since small-cap funds primarily invest in small-cap stocks, they can generate higher returns than large and mid-cap funds. But at the same time, the associated risk is higher.
Midcap funds invest a minimum of 65% of their assets in equity shares of organisations that rank within 101 and 250 with respect to market capitalisation. Generally speaking, mid-cap companies are more financially stable in comparison to small-cap organisations. This is one of the reasons why investments in mid-cap funds carry lower risk.
Large-cap funds are open-ended equity funds, investing at least 80% of their fund corpus in equity shares of companies ranked between 1st and 100th on the basis of market capitalisation. These equity funds are generally considered more stable because of their proven record and reputation. In other words, these companies are the leaders in their respective markets, delivering steady performances over a long period of time.
The returns are high but less compared to that of small and midcap funds. However, large-cap funds carry the lowest risk out of the three types of equity funds discussed above.
In this section, we will discuss the advantages of each of these funds.
Exponential growth potential
Small-cap funds come with tremendous growth potential. A small company with the right idea and an aggressive expansion plan can make rapid strides.
Exposure to undervalued stocks
It is likely that the underlying small-cap stocks are undervalued as the companies are relatively new in the industry. If companies are unknown or not well-recognised, there’s a possibility that their shares might be available at a discount.
Ability to generate outsized returns
Small-cap funds have the potential to outperform large-cap and mid-cap funds when the market is on a bull run. Accordingly, these mutual fund schemes give you the opportunity to earn substantial returns and grow your portfolio value quickly.
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Higher returns than large-cap funds
In contrast to large-cap funds, mid-cap funds have the potential to generate higher returns in the long run. Large-cap mutual funds invest in already mature organisations, where the scope for growth is less in comparison to mid-cap funds.
A less-riskier option than small-cap Funds
In contrast to small-cap mutual funds, mid-cap funds are less risky. Mid-cap stocks are generally less volatile than small-cap ones. Hence, in favourable market conditions, mid-cap mutual fund schemes can outperform small-cap funds.
A suitable option for long term investors
If you plan for wealth creation in the long run, these funds are a suitable option. Such funds invest the fund corpus in firms that are growing their business.
Large-cap funds invest in large-cap stocks. These firms are financially sound, and they grow consistently, generating decent revenue. Accordingly, they offer stability over the long term.
Ability to withstand a bear market
Such companies have the ability to power through an economic downturn. Out of the three major equity fund categories, these schemes are least affected by any market fluctuations.
Balances out risk and return
Large-cap mutual funds make their investment in blue-chip organisations that are known for reporting stable earnings and a proven track record. Accordingly, such funds offer low-risk returns while providing equity exposure.
That’s all about the advantages; now, let’s delve into the disadvantages of small, mid and large-cap funds.
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By now, you must be aware that these equity funds carry high risk. After all, the market conditions can severely impact the performance of the underlying small cap stocks. So, you must be careful when investing in them.
Subject to high volatility
Small-cap stocks are susceptible to high volatility when market sentiments are not strong. Accordingly, the net asset value (NAV) of such funds gets impacted.
Requires extensive research
There are a large number of small-cap stocks available in the market. These funds are unpredictable in terms of their performance. So fund managers need to carry out proper research before buying or selling the underlying assets.
Since these funds primarily invest in equity, the associated risk is high. A mid-cap fund can generate high returns in a favourable market scenario. That said, in case of a market downturn, the same fund may report substantial losses.
Fund managers of mid-cap funds need to alter the portfolio allocation according to the changing market conditions. On account of this, such funds incur high brokerage costs. As a result, these funds have a high expense ratio.
Large-cap funds offer steady and decent returns over a long period of time. However, the rate of return is lower compared to small-cap and mid-cap funds.
Low growth potential
As these funds invest in shares of companies that already have significant market share, there is little scope for growth.
Here we will compare these three sub-categories of equity funds to give you a better understanding.
|Parameters||Small-Cap Funds||Mid-Cap Funds||Large-Cap Funds|
|Risk Profile||These funds are the riskiest ones out of the three.||These funds are riskier than large-cap funds but less risky than small-cap funds.||These funds are the least risky as they invest in top 100 companies with respect to market cap.|
|Returns||These mutual funds can generate the maximum returns out of these three.||A mid-cap fund can generate better returns than large-cap funds but lower returns than small-cap ones. Accordingly, the potential for growth is moderate.||They can provide stable returns.|
|Volatility||Small-cap funds are highly volatile as they predominantly invest in small-cap stocks.||Mid-cap funds are less volatile than small-cap funds.||These funds are subject to less volatility in comparison to the other two types.|
|Availability of Information||Finding information related to small-cap companies can be challenging.||Finding information about mid-cap companies is easier than mid-cap organisations.||Information regarding large-cap companies is easily available.|
Small, mid and large-cap funds are all unique in their own way. All of them offer high returns over a long period of time owing to the equity exposure. However, there are some differences based on the rate of returns and risk involved. After all, in mutual funds, no one can guarantee the exact returns.
Hence, make sure to consider various aspects, such as your investment objectives, and investment time horizon, when making a choice between these three types of funds.
If you want to explore the power of passive investing, start with Navi. With the Navi app, you can get access to a host of funds, including the Nifty 50 Index Fund – a fund that invests in the top 50 companies.
Small, mid and large-cap funds are suitable for investors with different financial goals. After picking a category, ensure to compare the different schemes based on various aspects, such as past returns, the experience of the fund manager, etc., before making a decision.
Ans: No mutual fund is entirely safe. The returns cannot be guaranteed. However, large-cap funds are the safest options as they invest in top companies with a proven track record over a long time.
Ans: The thumb rule in the case of mutual funds is that the longer you invest, the better it is for you from a returns perspective owing to the power of compounding.
Ans: Mid-cap mutual funds are comparatively less risky than small-cap funds. However, they offer lower returns than small-cap ones. So, whether you should invest in mid-cap or small-cap funds depends on your investment goals and risk appetite.
Ans: The Lock-in period is the minimum duration for which no units can be sold or redeemed.
Ans: Other types of equity funds include ELSS funds, sectoral/thematic funds, value funds, multi-cap funds and Flexi cap funds.
Before you go…
Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully before investing.