You may have often heard that equity mutual funds invest across market capitalizations (MCap), while some of them invest specifically into a single genre of market cap. However, not many of us have given a thought to the relevance of investing into different market caps and the likely impact on returns.
Understanding the relevance of M-Cap (Market cap)
Market capitalization of a stock is arrived by multiplying outstanding shares in a company with the current market price.
As a general rule, one categorizes market caps under : Largecap, Midcap and Smallcap. A company with greater than Rs. 5000 crore market cap is categorized as Largecap stock, one with greater than Rs. 500 crore but less than Rs. 5000 crore is termed as midcap stock, one with lower than Rs. 500 crore is a smallcap stock. This definition is not sacrosanct and individual fund managers may tweak the limits appropriately to suit his needs.
Generally, Largecap stocks are also dubbed as bluechip stocks and are perceived to be less risky.
Mutual funds aligned to market cap
When a mutual fund is described in terms of market cap (i.e. small cap, mid cap or large cap), it indicates the size of the companies in which the fund invests, not the size of the mutual fund itself.
Smallcap Funds
Smaller companies are those in the early stages and have been generally in existence for lesser number of years. They could have significant growth potential, but are not as financially strong or as established as large companies. Typically, one would look at these companies with a perspective of 3 years, thereby ensuring that as the company grows substantial returns are also derived. These companies do not have steady earnings ability and hence, the funds can be quite volatile. Smallcap funds can also be great investments for those who can tolerate more risk and are looking for more aggressive investment options. Within the Indian Mutual fund industry there are not many funds that solely invest in smallcap, they usually have a blend of midcap stocks as well. This is to protect any extreme downside because smallcap companies sometimes do not survive a downfall and there are times when they are forced to go out of business.
Midcap Funds
Midcap companies have some the growth prospects of smallcap companies, but they entail less risk because they are slightly larger (typically fall between the largecaps and smallcaps, hence are considered to be of moderate risk profile within the equity category). Midcap funds don’t always move with the broader market, and they are also usually not as prone to violent swings as small caps. Midcap funds can be great investment vehicles for investors seeking a fund with great return possibilities without the risk of small caps and the passiveness of index-related returns (largecaps).
Largecap Funds
Largecap funds are ones that invest in the “big fish” among stocks. These are perceived to be companies that have attained a certain sense of stability and are likely to be less volatile. They may not provide stellar returns but are most likely to not shock you on the downside either. To a certain extent largecap funds are also aligned to the broader indices since most of the larger companies would be a part of the index. Largecap funds can be great for investors who have longer-term investment timelines and would like to buy and hold. They are a little passive in their investment strategy and often do a top down approach and watch the sector cycles very closely.
The guiding factor for choosing the right market cap would be your risk appetite. In order to achieve diversification investors often choose to go with a blendcap approach and invest across market caps.
The idea is to understand the relevance of market cap and choose the fund that suits you best! Different market caps serve various purposes; largecap funds are relatively low risk.
One should go easy on smallcap funds because they are highly risky A combination of various market caps would help one achieve optimal returns at relevant risk adjusted levels Irrespective of which market cap one opts for, one should use the systematic investment approach to help reduce the downside risk significantly.