When most people think of investing in a mutual fund, they usually tend to focus on the individual stocks or bonds that make up the fund. However, it’s also important to consider the size of the companies in which the fund is investing. This is typically indicated by the fund’s market capitalisation, or “market cap”, which is the market value of the publicly traded company.
A company’s market capitalisation is calculated by multiplying a company’s total outstanding shares in the market by the current market price of each share. Market cap is a good metric to understand a company’s size and evaluate the risks of investing in its shares. This knowledge can help you choose a fund that’s aligned with your risk tolerance and investment objectives. On that note, here’s a quick overview of the different types of mutual funds based on market cap.
Mutual funds and market capitalisation
Regulated by the Securities and Exchange Board of India (SEBI), mutual funds are usually classified into three broad different categories based on market capitalisation. They are:
- Large cap
- Mid cap
- Small cap
Large-cap funds: Invest in the top 1-100 companies
A largecap fund invests in at least 80% of the fund’s assets in stocks of large companies with a market capitalisation exceeding Rs 20,000 crore. SEBI defines large-cap companies as the top 100 well-established companies listed on stock exchanges in terms of market capitalisation.
These companies have strong fundamentals, including strong earnings, cash flow, and balance sheets. They have a significant market presence and are less volatile compared to small and mid-stocks. Thus, those investors who want to generate steady returns at relatively low risk can invest in large-cap mutual funds.
Mid-cap funds: Invest in companies ranked 101-250
A mid-cap fund is a mutual fund that invests at least 65% of the total fund pool in stocks of medium-sized companies with a market capitalisation of Rs 5,000 – Rs 20,000 crore. Mid-cap companies are relatively new and generally rank between 101-250 in terms of market cap.
They tend to be more volatile compared to large-cap stocks, but they also have the potential to evolve into large-cap companies over the long term. While mid-caps may not offer the same level of stability as large-cap mutual funds, they can provide a higher level of growth potential.
Small-cap equity funds: Invest in companies ranked 251 and below
A smallcap fund invests in stocks of small companies that rank from 251 onwards on the stock exchange. Small caps companies have a market capitalisation of less than Rs 5,000 crore. While there are certainly some exceptions, most small-cap companies are relatively young and lack the resources and track record of their larger counterparts. As a result, they tend to be more prone to sharp swings in stock prices. They may offer high returns during bull markets but can also incur heavy losses during bear markets.
Closing thoughts
In addition to these three categories of equity mutual funds based on market cap, there are also multi-cap funds. These funds have a minimum 25% asset allocation across large-cap, mid-cap, and small-cap stocks each, offering better diversification.
All investors, whether new or experienced, should pay attention to market capitalisation when making investment decisions. By understanding scheme characteristics and the risks involved, investors can create a diversified portfolio that comprises a mix of market caps and strike a balance between risk and returns.