One of the most important classifications of equity mutual fund schemes is by market capitalization profile of the underlying scheme portfolio. Market capitalization is defined as the share price of a company multiplied by the number of shares outstanding. In order to ensure standard definition of different market capitalization segments in investment universe for equity schemes, SEBI has defined large cap, midcap and small cap stocks as follows:-
- Large Cap: 1st - 100th company in terms of full market capitalization
- Mid Cap: 101st - 250th company in terms of full market capitalization
- Small Cap: 251st company onwards in terms of full market capitalization
Accordingly, equity mutual fund schemes can be classified as large cap, midcap and small cap funds as per their investment characteristics. We will discuss the different characteristics of these three equity fund categories in this blog post.
Large Cap Funds
- Mutual fund schemes which invest at least 80% of their assets under management (AUM) in large cap stocks are categorized as large cap funds.
- Large cap stocks usually have long histories, large market share in their respective industry sectors, revenue base and balance sheets.
- Owing to their financial strength, large cap companies are usually less vulnerable during economic downturns. As such large cap stocks are considered to be less risky than midcap and small cap stocks.
- The large cap segment, as represented by the Nifty 100 index constitute around 75% of the free float market capitalization (as on March 31, 2017 per NSE).
- Large cap equity funds are less volatile compared to midcap and small cap equity funds. At the same time, the ability of these schemes to generate high returns is relatively lower than midcap and small cap funds because the large cap segment of the market is more efficient.
- Large cap funds usually underperform versus small and midcap funds in bull markets, but outperform in bear markets.
- Mutual fund schemes which invest at least 65% of their assets under management (AUM) in midcap stocks are categorized as midcap funds.
- Midcap stocks have smaller market share and balance sheets compared to large cap stocks, but larger market share and balance sheets compared to small cap stocks.
- Midcap companies are more vulnerable than large cap in economic downturns but less vulnerable than small cap.
- The midcap segment of the market, as represented by the Nifty Midcap 150 index constitute 13.5% of the free float market capitalization (as on March 31, 2017 per NSE).
- As such, the risk profile of midcap funds is higher than large cap funds, but lower than small cap funds. Since the midcap market segment is much smaller than the large cap segment in terms of overall market capitalization, midcap stocks tend to be less extensively researched compared to large cap stocks. This provides the midcap fund managers, greater scope of price discovery and ability to generate higher returns compared to large cap funds. Also, high growth midcap stocks have the potential of becoming large cap stocks in the future, leading to further valuation re-rating and higher returns.
- Midcap funds are more volatile than large cap funds, but less volatile than small cap funds. Midcap funds tend to outperform large cap funds in bull markets, but underperform in volatile or bear markets.
Small Cap Funds
- Mutual fund schemes which invest at least 65% of their assets under management (AUM) in small cap stocks are categorized as small cap funds.
- Small cap stocks have smaller market share and balance sheets compared to midcap stocks, but quality small cap stocks have the ability to deliver high revenue and earnings (EPS) growth compared to large and midcap stocks, owing to their smaller base and industry sector niches they occupy.
- However, small cap companies are more vulnerable in economic downturns compared to large and midcap companies. As such, the risk profile of small cap stocks and funds are higher than midcap and large cap funds.
- The small cap segment is the smallest market cap segment of the market (smaller than midcap).
- The small cap segment is the least researched segment of the market, allowing large scope of price discovery by fund managers of small cap schemes. Over the long term, small cap funds have the potential of giving higher returns than midcap and large cap funds. Further, today’s high quality small cap stocks can become midcap or even large cap stocks in the future, thereby leading to considerable valuation re-rating and high returns in the long term for investors.
Investors should consult with their financial advisors to understand their risk appetites and make the right investment decision.
Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.
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