When making mutual fund investments, you will come across funds that are categorised based on the market capitalisation or market cap of the companies they invest in. To understand what that means, ask yourself how you assess the market value of a company. Is it by how popular the company seems to be with its customers or is it by the price of its stock? The answer is neither.
That’s because customers can love a company but that doesn’t accurately reflect its value and a company’s stock can be for Rs. 1,000 but that doesn’t mean it’s more valuable than companies with lower stock prices. Instead, the market cap is an accurate way to evaluate the value of a company. It considers the stock price of the company and multiples it with the company’s outstanding shares. Hence, the market cap indicates a company’s value or size.
Now that you know what market cap is, let’s look at the types of mutual funds in India based on market capitalisation:
Large-cap equity funds
These are mutual funds that invest primarily in stocks of large-cap companies. Large-cap companies are the top 100 companies listed on a stock exchange as per their market capitalisation. For instance, Reliance Industries Ltd. is listed as one on the Bombay Stock Exchange (BSE) with a market cap of Rs. 15,02,444.35 crore. Large-cap companies are well-established and often dominate the industry they are in. Think of Bharti Airtel, Larsen & Toubro, Nestle India Ltd., etc. Hence, large-cap equity funds are associated with stability and security. However, their return potential isn’t as high as that of mid-cap and small-cap companies.
Mid-cap equity funds
Mid-cap companies are the ones between 101 and 250th on a stock exchange with regard to their market capitalisation. Compared to large-cap companies, they are still developing and have the potential for growth, and hence mid-cap equity funds can offer better returns. However, they also carry more risk in comparison. When you compare mid-cap equity funds with small-cap funds, the opposite is true.
Small-cap equity funds
Small-cap companies are the ones listed from the 251st position and small-cap equity funds primarily invest in them. Small-cap companies are relatively newer and smaller companies and hence, while they have a lot of growth potential, the risk of failure and volatility is also higher.
Multi-cap equity funds
These are equity mutual funds that invest in companies across the three market capitalisations. The Securities and Exchange Board of India (SEBI) requires multi-cap funds to invest a minimum of 25% in each large-cap, mid-cap, and small-cap stocks. Multi-cap funds are hence more diversified in terms of the market cap of companies they invest in.
Like multi-cap equity mutual funds, flexi-cap funds can also invest in companies across different market caps. The differentiating factor is, however, that they are not required to stick to any mandatory prescribed limits. That means flexi-cap funds are free to reduce their exposure to mid-cap and small-cap stocks below 25% all the way to zero given the market conditions.
Equity funds that are categorised based on the market cap of the companies they primarily invest in have different risk-return profiles and offer different upsides. For instance, historically, small-cap equity funds have outperformed large-cap funds in times of economic booms. On the other hand, during recessions, large-cap funds have been more stable than small-cap and mid-cap funds. Hence, when making mutual fund investments, you need to consider these factors.