When you hear the terms large cap funds, mind cap funds and small cap funds, you might be inclined to wonder if the terms refer to the size of the mutual funds. However, these terms refer to the size of the companies that the mutual funds invest in. Let’s dive right into it and let’s start at the very beginning.
When you invest in a mutual fund, your capital is pooled with that of other investors and invested in debt and equity. Debt refers to bonds and other fixed-income stock market instruments. We’re not talking about that in this article, today. We’re talking about the other part, that is equity. Equity refers to the stocks of companies listed on the stock market. The fund manager of the mutual fund you have chosen, along with their team, will select shares of companies based on their predictions of which companies will perform well, or experience rising stock prices. But shouldn’t you have some say in what kind of companies they pick? Well, you do. You choose, based on the names of the funds. For example, when you choose XYZ large cap fund, you are choosing a low risk profile and stable potential earnings, that might not show any huge leaps, but will be sustainable in the long term.
What is market capitalization
The companies listed on the stock market may be divided into large cap, mid cap and small cap companies based on their market capitalisation. Market capitalisation refers to the total value of shares on the market, also known as the total value of outstanding shares on the market. It is arrived at by multiplying the share price by the number of shares on the market. Companies with a higher market cap, or large cap companies will usually be the most stable and would be expected to have the lowest risk. Correspondingly medium cap companies would be expected to exhibit an average amount of stability and risk, and small cap companies are expected to show more volatility and high risk.
Mutual funds will usually target investors based on their risk appetite. Large cap mutual funds target investors who have a low risk appetite and correspondingly for medium and small cap funds. Today, there are also hybrid funds and multicap funds that offer portfolio diversification or exposure (which essentially means the opportunity to win or to lose) to companies of multiple, all market capitalization sizes.
Characteristics of mutual funds based on market capitalization
Let us explore the features, benefits and considerations linked to the various categories of mutual fund market capitalization in india
Large cap mutual funds
These mutual funds will invest in large cap companies. Large cap companies are expected to offer stable and sustainable returns in the long term and are expected to show resilience in times of great volatility or during economic recession. Large cap companies are typically market leaders in a given sector and will usually have a large number of shareholders and a large volume of shares available for trading, which makes their prices nearly impossible to manipulate.
On the other hand, investors should remember that market capitalization is a product of stock price and the stock price can be unnecessarily inflated due to hype or any other factors. Fund managers are expected to pick carefully from among large cap stocks so as to maximize returns to investors. Not any large cap stock will cut it. Different large cap mutual funds will use different strategies and might purchase different large cap stocks, from different sectors.
Mid cap mutual funds
The companies chosen by mid cap funds might not be well-established and are unlikely to be market leaders but will have shown tremendous development and will be in a phase of good growth.
Because they still have a long way to go, there is a higher potential for investors to earn. But because they are not market leaders, there is always a chance that the market leader will elbow them out of the way, or that they will make a mistake move and that investors will incur losses. It is up to fund managers to choose companies correctly, based on their financial health and their potential.
Small cap mutual funds
As you would have guessed from the previous two descriptions, small cap mutual funds invest in companies which have a small number of shareholders and a small amount of market capitalisation, typically less than 100 crores. A lot of startups and family-owned businesses that get listed might initially fall in this category.
Investors who are able to spot companies that represent an opportunity have the chance of participating in the growth run of these small cap stocks. Typically, fund managers should have the necessary expertise to choose the right kind of small cap stocks so as to deliver maximum returns to investors. Nonetheless, small cap mutual funds will usually target investors with a high risk profile because although one expects the fund manager to choose right, the risk profile of the stocks is high and consequently the mutual fund becomes high risk. The appeal for investors is potentially high returns.
Investors can choose large cap funds for stable returns and low risk; mid cap funds for average returns and average risk and small cap funds to target high earnings with the price of high risk. Hybrid funds are also available for investors who would like to try their luck with all levels of market capitalization. Whatever the investor chooses, there will always be some level of risk because mutual funds are stock market investments, and therefore subject to market risk. Moreover, market capitalization is not the only indicator of whether a stock presents a risk to investors or not.