Large-Cap, Mid-Cap, or Small-Cap: Which Equity Fund is suitable for you?

Equity Mutual Funds

Equity mutual funds invest in the shares of companies listed on the stock exchange. However, the universe of equity funds is vast. Within it, there are several fund categories, each of which may be suitable for different kinds of investors or investment goals.

It is therefore essential to understand the various categories of equity mutual funds in India to select the one that is aligned with your financial planning requirements. Choosing the right type of fund is crucial for potentially reaching your investment goals.

One way in which equity funds can be categorised is in terms of the market capitalisation of the companies in which they invest. This article tells you more about equity funds that invest in large-cap, mid-cap, and small-cap stocks to help you make an informed decision.

What are Equity Mutual Funds?

As the name suggests, equity mutual funds invest primarily in equities – stocks and shares of companies. Returns are generated if the value of the underlying stocks rises, or if the company that they invest in declares dividends. Over time, equity investments have the potential for significant growth. However, they also come with high risks, because their performance is directly linked to that of the companies they invest in.

This, in turn, can be influenced by market sentiment, economic indicators, the company’s business performance, and geopolitical events, among other factors. However, not all companies respond in the same way to these external triggers. The company’s size, legacy, and fundamentals can influence its growth potential and vulnerability to volatility to a great extent. This is where market capitalisation comes in.

Understanding Market Capitalisation

Market capitalisation or market cap is the total market value of a company’s outstanding shares. It is calculated by multiplying the current share price by the total number of outstanding shares. Based on market cap, companies can be classified as:

  1. Large-cap: Listed 1 to 100 on the stock exchange
  2. Mid-cap: Listed 101 to 250
  3. Small-Cap: Listed 251 and beyond

Based on the scheme category, an equity mutual fund may invest either primarily in large-cap, mid-cap, or small-cap stocks or in a combination of two or three.

Large-Cap Funds 

Such funds invest primarily in well-established companies that are typically industry leaders with a track record of strong performance. Due to their size and relative stability, large-cap companies are typically less volatile than mid-cap and small-cap companies. However, their return potential is also lower, as they are no longer in the rapid expansion phase.

Such funds can therefore be suitable for investors seeking a balanced approach with the potential for stable returns and relatively low volatility.

Mid-Cap Funds

These funds invest in companies that are in the growth phase and are seeking to become large-cap companies in the future. They are riskier than large-cap funds but also offer higher growth potential. They are suitable for investors seeking high growth potential and are comfortable with high risk and some degree of volatility.

Small Cap Funds

Small-cap funds invest in companies that are in the early stages of their business lifecycle. These companies offer very high growth potential in the right market conditions – but come with very high risk and volatility. They are most vulnerable to market movements, economic trends, and other external triggers and can lead to significant losses, especially during downturns. Therefore, they may only suit very high-risk investors who have a long investment horizon that spans multiple market cycles to potentially tide over short-term volatility and downturns.

Mutual Funds Combine more than one Market Cap

Investors seeking a better risk-reward balance can also consider diversifying their portfolio across large-cap, mid-cap, and small-cap stocks. They can do so by investing in different equity funds or by choosing diversified schemes. These include:

Large and mid-cap funds: Invests in large as well as mid-cap stocks (minimum 35% allocation to each).

Multi-cap funds: Invest in large, mid, and small-cap stocks (minimum 25% allocation to each).

Flexi-cap funds: Can freely invest across large, mid, and small-cap stocks, with no market-cap-wise minimum allocation requirements.

Risk Mitigation Through SIP 

Another way to potentially mitigate risks while investing in equity mutual funds is by choosing a systematic investment plan or SIP.

SIPs involve investing a fixed amount regularly, spreading out your investment over time. This way, you invest in different market conditions, including ups and downs. This consistent investment approach can help manage and leverage market fluctuations and potentially reduce the impact of volatility on your investment.

This is because of the rupee cost averaging. Because you are investing a fixed amount regardless of market conditions, you buy more units when prices are low and fewer when prices are high. Over time, this strategy typically reduces the average cost per unit of your investment, smoothing out the effects of market ups and downs. This also helps optimise return potential when the market rises.

Additionally, the disciplined approach of SIPs encourages regular and long-term investing, which is important for navigating the unpredictability of equity markets.

Choosing between large-cap, mid-cap, and small-cap equity investments depends on your individual preferences, risk tolerance, and investment goals. Large-cap funds are the least volatile of the three and offer potential for relatively steady growth, mid-cap funds offer higher growth potential but with higher accompanying risk, and small-cap funds offer significant growth potential but at very high risk. Investing in SIP can help potentially enhance risk mitigation when investing in equity mutual funds.

Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.

Also Read: Bajaj Finserv Multi Asset Allocation Fund: Diversify across asset classes to improve portfolio resilience

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