Difference between large cap, mid cap & small cap funds

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. What is market capitalisation?
2. Understanding large cap, mid cap, and small cap funds
3. Large cap vs mid cap vs large fund asset allocation
4. Risk and return potential of large cap, mid cap and small cap funds
5. How to choose between small-cap, mid-cap and large-cap funds?
6. Who should invest in small-cap, mid-cap and large-cap funds?
7. Factors to consider when choosing between small-cap, mid-cap, and large-cap stocks

What is market capitalisation?

Market capitalization, often referred to as market cap, is a measure of a company's total value as determined by the stock market. It is calculated by multiplying the current market price of a company's outstanding shares by the total number of outstanding shares. Market cap categorizes companies into different sizes: large-cap, mid-cap, and small-cap. Large-cap companies typically have higher market caps, indicating they are more established and generally have a lower risk profile. Market cap is a key metric used by investors and analysts to evaluate a company's size, performance relative to peers, and its potential for growth or decline in value.

Understanding large cap, mid cap, and 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.

Large cap vs mid cap vs large fund 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.

Risk and return potential of large cap, mid cap and small cap funds

• 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.

How to choose between small-cap, mid-cap and large-cap funds?

Selecting a suitable category of mutual funds depends on your financial goals, risk tolerance, and investment horizon. Evaluate your risk appetite. Note that all equity funds require a high risk appetite, but large cap funds may be less risky than small cap and mid cap funds. Also consider the growth potential you need based on your goals and your investment horizon. Small and mid cap funds may require a slightly longer horizon than large cap funds as they are more prone to volatility, especially in the shorter term. Lastly, before choosing a scheme, consider the expense ratio, investment strategy, fund management team and past performance data, if available. (Past performance may or may not be sustained in the future).

Who should invest in small-cap, mid-cap and large-cap funds?

1. Large-cap funds:

• Investors seeking a balance between relative stability and potential for steady long-term growth.
• Individuals approaching retirement or those with medium-to-long term financial goals.

2. Mid-cap funds:

• Investors with a very high risk appetite who seek a blend of long-term growth potential with some mitigation of downside risk.
• Investors with long-term goals exceeding five years

3. Small-cap funds:

• Aggressive investors with a high tolerance for volatility.
• Individuals with very long-term goals such as potential wealth creation or legacy planning.

Factors to consider when choosing between small-cap, mid-cap, and large-cap stocks

1. Risk appetite:

• Large-cap funds: Suitable for investors comfortable with investing in equities but seek relative stability and potential for relatively steady returns in the long term.
• Mid-cap funds: Suitable for investors with a higher risk appetite who want more growth potential and are comfortable with greater volatility.
• Small-Cap Funds: Best for aggressive investors comfortable with high volatility in pursuit of potentially higher long-term returns.

2. Investment goals:

• Large-caps focus on lower volatility on invested capital and potential for relatively steady returns.
• Mid-caps offer more long-term growth potential with higher volatility
• Small-caps provide higher returns in the long term but with more volatility.

3. investment horizon

• Large-cap funds can be suitable for long term goals of around 5 years.
• Mid-cap funds are suited to longer term goals of five years or more
• Small-cap funds are suitable for more long-term objectives (7+ years).

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. Using tools like SIP calculator online can help investors estimate the future value of their investments, providing valuable insights when deciding the right mix of funds to include in their portfolio. 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. A lumpsum calculator mutual fund can be a useful tool to compare the potential returns of each market capitalization category, helping you choose funds that align with your investment goals and risk tolerance. Investors can also use tools such as a compound calculator to visualise the potential returns on their investment. Based on your investment amount, tenure and expected returns, the calculator gives you the potential size of your final corpus. This can help you in investment planning. 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.

Should I buy small cap funds or large cap funds?

The suitable fund category for you depends upon your risk appetite, goals and investment horizon. Small cap funds may offer better long-term growth potential but entail significantly higher volatility risk. Large cap funds offer the potential for relatively stable long-term returns because they invest in well-established companies that may not have the same scope for expansion as small caps but are typically better able to weather volatility.

How are large-cap, mid-cap and small-cap funds in India categorised?

Large cap, mid cap and small cap funds are different categories within the broad bucket of equity mutual funds. Large cap funds need to invest at least 80% of their portfolio in equity and equity-related instruments of the countries largest companies by market capitalisation (those listed between 1 and 100 on the stock exchange). Mid-cap funds need to invest 65% of their portfolio or more in companies listed between 101 and 250, while small cap funds need to invest 65% of their portfolio in companies listed 251 and beyond.

How can you use large-cap vs small-cap or large-cap vs mid-cap in your investment portfolio?

Large-cap funds offer relative stability and potential for relatively steady long-term growth. Small-cap funds provide higher growth potential but higher risk, while mid-cap funds seek to offer better growth potential than large caps with lower volatility risk than small caps. The three can be combined in a diversified portfolio, or investors can focus on either on category based on their risk appetite and goals.

What is the nature of large-cap vs mid-cap funds?

Large-cap funds are typically less prone to volatility as they invest in established blue-chip companies with a track record of relatively consistent growth. Mid-cap funds are more volatile, focusing on mid-sized companies with more scope for growth but with higher volatility.

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.