While investing in Mutual Funds, knowing which scheme to invest in is not enough. Read this space to know about the kind of companies these schemes invest in.
Often, while doing research on which Mutual Fund scheme to invest in, investors might have encountered terms like small cap, mid cap, and large cap funds. Prospective investors need to have a clear understanding of market capitalisation before they begin to invest in Mutual Fund schemes.
For the uninitiated, the word ‘cap’ refers to the market capitalisation, or the size of a listed company. A company’s size is an important criterion for Mutual Funds when picking stocks for equity portfolios. This is because investing in a company will bring with it unique opportunities and risks. However, the gains and losses of large-cap investments are different from those of a small-cap fund investment.
Generally, the Scheme Information Document of a Mutual Fund scheme will contain the definitions of large cap, mid cap, and small cap.
Additional reading: Best Tax Saving Mutual Funds In 2018
Large cap funds
Large cap funds are those funds which invest a larger proportion of their corpus in companies with a large market capitalisation. These comprise of old and well-established players with a good track record and strong corporate-governance practices.
These funds have consistently generated wealth for their investors slowly and steadily over a long term. These corporate houses are usually among the most highly followed and well-researched on the market. Mutual Funds that invest a majority of their investible corpus in these companies are labelled as large-cap funds.
Companies in large cap funds are steady compounders and regular dividend payers. On the risk-return spectrum, large-cap funds deliver steady returns with relatively lower risk, compared to mid-cap and small-cap funds.
Large cap funds are great for investors who have longer-term investment timelines and a lower risk appetite. So, adopt a long-term perspective, stay patient, and remain invested to reap good returns over the long term.
Additional reading: Everything You Need To Know About New Fund Offers in Mutual Funds
Mid cap funds
In between large caps and small caps in terms of company size, mid cap funds are a popular choice among the general investing public. Mid cap funds invest in mid-sized companies that show tremendous growth potential to become large companies or leaders in their own field.
Underlying stocks in mid cap funds are more volatile than large cap funds. Mid cap funds can be great investment vehicles for investors seeking a fund with great return possibilities and index-related returns like those of large caps, but without the risks associated with small cap funds.
The basic premise of investing in mid cap schemes is to give it a lot of time. Ideally, one should invest in a mid cap scheme only if one has an investment horizon of seven to ten years. The trick is to find a good scheme that has been around for a while and stay invested even when times are bleak. Rest assured, you will see impressive returns at the end of your investment horizon.
Small cap funds
Small cap funds invest in companies that are young and seek to expand aggressively. These companies have the highest growth potential and are more vulnerable to market vagaries. Smaller companies are presumed to have significant growth potential but are not as financially strong or as established as larger companies.
In times of great instability, small cap funds can suffer greatly as less established companies go out of business. Investors with a good risk appetite who can tolerate more risk and are looking for more aggressive growth should park their money in these funds.
Choosing the right fund should be in line with risk appetite, return expectations and the investment horizon of the investor. Investing in these funds can also be done via Systematic Investment Plan (SIP), wherein a fixed sum is invested in funds at regular intervals, which averages out the cost. In essence, buy more units when the Net Asset Value (NAV) falls and less when the NAV rises-thereby reducing volatility across market cycles.
Additional reading: Mutual Funds Taxation Post Budget: All You Need To Know
Why do small-cap funds produce greater returns than large caps/mid caps?
Generally, small and mid cap companies have the ability to produce greater returns since small businesses tend to be more growth-oriented than larger conglomerates. For instance, a company with a $1B market capitalisation can easily double its market capitalisation as compared to a large conglomerate of $50B. And since share price is an important factor in measuring market cap, a rapidly growing market cap most often translates to the price of the stock climbing higher as well.
Investing in either of these three kinds of funds depends entirely on your risk appetite and investment goals. As always, you need to do plenty of homework and research to find out which funds best suit your portfolio. Understanding the pros and cons of various market cap funds is the first step towards determining which fund will suit your investment style.
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