Large, Multi and Small-Cap Mutual Funds: How to decide which work best for you?

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Updated: Oct 31, 2020 11:40 AM

Investment-related risks vary from one equity fund category to another. So, how to know which category is best suited for you?

If you’re a young investor with a high returns expectation and a high risk appetite, top-rated small and mid-cap funds could be rewarding investment products for you.

Whether you’re a newbie or an expert, equity mutual funds usually allow a hassle-free opportunity to all types of investors to put their money into different types of asset classes. Depending on your age, risk-taking ability, financial goals, and returns expectations, you may invest in large-cap, mid-cap, multi-cap, or small-cap equity funds where ‘cap’ stands for market capitalisation.

This indicates the size of companies in which the funds are invested in. For the purpose of mutual fund categorisation, SEBI ranks companies by their market capitalisation. Companies ranked 1 to 100 are large-cap; 101 to 250 mid-cap, and 251 onwards are small-cap. A large-cap fund must have a minimum 80% of total assets invested in equity securities of large-cap companies; a mid-cap fund should have at least 65% of total assets invested in equities of mid-cap companies, and a small-cap fund should have at least 65% of total assets invested in equities of small-cap companies.

Investment-related risks vary from one equity fund category to another. So, how to know which category is best suited for you? Here are some things to keep in mind.

Investing in small and mid-cap funds

If you’re a young investor with a high returns expectation and a high risk appetite, top-rated small and mid-cap funds could be rewarding investment products for you, assuming a long investment tenure which your lower age provides. These funds could allow you the opportunity to get high returns if you are willing to take high investment risks. The earlier you start, the more time your investments will get to grow and produce the desired results. A longer investment period would also help in lowering the risk associated with the small and mid-cap funds.

Later, as you approach middle age, when your financial responsibilities increase, you may gradually shift your investment focus from high-risk options to comparatively lower risk and less volatile funds that can still give you good returns. That being said, investment diversification is crucial; so always diversify your investments across different asset classes, within the same asset class and also across different mutual fund companies. Young persons can take greater exposure to small and mid-cap funds compared to older investors, but the exposure still needs to be in line with investment goals.

Investing in multi-cap funds

In a recent circular, the SEBI stated that the minimum allocation to equity should be 75% of the corpus in a multi-cap fund. Out of the 75%, there should be a minimum allocation of 25% each in large, mid, and small-cap equity securities, respectively. Earlier, the fund managers of multi-cap funds had the flexibility to invest the money as per their choice across equities with diverse market capitalisations.

If you are looking to invest in equity funds but don’t want high-risk exposure like in small and mid-cap funds, you may invest in top-rated multi-cap funds. These suit both young and middle-age investors. These funds are also well-diversified in terms of market capitalisation.

Multi-cap funds may give you a comparatively lower returns than small and mid-cap funds when the markets are stable, but when they turn volatile, these funds carry lesser risk. So, if you are looking for a fund that automatically adjusts to market volatility by switching allocation from lower to mid-cap or large-cap funds and vice-versa, multi-cap funds could be the right choice for you.

Investing in large-cap funds

If you’re in the mid-age group and looking for higher returns than debt funds but don’t want to take high investment risk, you may go for large-cap funds. They could also offer stable returns in a volatile market. Large-cap funds usually carry lower risk and therefore provide moderate returns compared to funds with higher exposure to mid and small-cap equities. If you are close to retirement, or in the mid-age group with high financial responsibility, or a young investor with low risk tolerance, top-rated large-cap funds could be your best investment choice among other equity mutual fund products.

Final thoughts

Like any other investment product, the selection of equity mutual fund products should also be strictly based on your financial goals. If your financial goals are very long-term and you have a high risk appetite, you may invest a higher portion of your equity allocation in small and mid-cap funds. If your financial goals are for mid to long-term and your risk appetite is moderate, you may allocate a greater portion of your corpus in multi-cap funds. If your financial goals are for the medium term and your risk appetite is moderate to low, you may invest a major portion of your equity allocation in large-cap funds.

Also, you must shift your allocation from small/mid-cap to multi-cap and large-cap as you grow older, with a change in your risk appetite or returns expectations. Do note, however, that past performances do not guarantee future returns and it’s always better to consult a certified investment planner if you’re unable to lay out a strategy on your own.

(The writer is CEO, BankBazaar.com)

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