Why do some experts consider the best midcap fund safe and the best small-cap fund volatile? Which one should you choose?
These may be some of your questions regarding midcap and small-cap funds.
Midcaps and small-caps are the two most popular categories in equity mutual fund portfolios. However, there is a wide disparity between them regarding performance, risk, and return.
Let’s take a closer look at both of them.
Understanding market capitalization
Market capitalisation is a key concept in understanding mid-cap and small-cap funds.
Market capitalisation or market cap is the total value of all stocks or shares of a company outstanding on the stock exchanges. For example, if a company has 100,000 shares that have been issued at ₹10 each, the market cap for this firm would be ₹10 lakh.
Companies are categorised based on their market capitalization as follows:
- Small-cap: Market cap <₹ 5000 crores
- Mid-cap: Market cap ₹ 5000 crores – ₹ 20,000 crores
- Large-cap: Market cap >₹ 20,000 crores
What are midcap funds?
Midcap stocks are those with a market capitalisation ranging from ₹5000 crores to ₹20000 crores. Mutual funds focusing on midcap stocks are called midcap funds. SBI Magnum midcap fund, Kotak Emerging Equity Fund, and HDFC Midcap Opportunities Midcap Fund are some of the prominent midcap funds in India.
Although more volatile than large-cap funds, the best midcap funds are considered safer than small-cap funds since they are less prone to volatility and deliver superior returns over a longer period.
How to find the best midcap fund
As an investor, your aim must be to find the best midcap funds to invest in. Here are two things to look at:
While looking for the best midcap fund, the first factor you need to look at is diversification. A well-diversified portfolio helps reduce overall risk by spreading investments across various sectors. Ensure their portfolios are not overly concentrated in any single sector.
- Fund Manager’s Track Record
While investing in a mutual fund, you trust the fund manager to manage your money. Hence, the next important factor for you to consider is the credibility of the fund manager.
While past performance cannot guarantee future results, it indicates a fund manager’s expertise. Ideally, you should look for managers who have shown consistent returns. You can also use fund ratings that objectively assess a fund manager based on their track record.
What are small-cap funds?
A small-cap fund focuses on investing in stock with a market capitalisation of fewer than ₹ 5000 crores. Since small caps are relatively riskier compared to midcaps, they often deliver much higher returns in the short term. However, you must remember that these stocks are extremely volatile and usually experience sharp declines. Hence, while small-cap stocks are great for generating quick gains, they have fewer chances of providing long-term returns.
Axis Small Cap Fund, ICICI Prudential Small Cap Fund, and DSP Small Cap Fund are some of India’s most prominent small-cap funds.
How to choose the best one to invest in?
Here are two factors you need to consider while choosing the best from a bouquet of small-cap funds:
- Past Performance:
To know whether a fund is performing well, you must keep an eye on its past performance. Although past performance doesn’t always indicate future results, it gives us an idea about a fund’s ability to generate returns.
You should also remember that just because a fund hasn’t performed well in the past doesn’t mean it won’t perform well in the future. Several examples of funds that lost money in the last few years but recovered to beat the market.
That being said, since small-cap stocks are highly volatile, you want to ensure that the fund manager can manage such volatility.
- Sector Exposure
Small-cap stocks are heavily dependent on the domestic economy. Hence, you should take a close look at the diversification aspect of different small-cap funds before investing.
Ideally, you should look for funds that have exposure to multiple sectors. For example, if the fund predominantly invests in consumer stocks, it may suffer during a downturn in the domestic economy. On the other hand, small-cap funds investing in various sectors, such as consumer, IT, banking, and others, will be better positioned to deal with an economic downturn.
Midcap Funds vs. Smallcap Funds: Benefits and Drawbacks
Now that you have an idea of midcap and small-cap funds, you must wonder which one you should invest in.
The best midcap funds will suit you if you are looking for long-term investment opportunities.
As discussed earlier, midcaps are more stable than small-cap funds, which means they are less vulnerable to volatility. They also provide greater stability in the long term.
However, you need to know that despite their long history of strong returns, midcap funds have not always been reliable. In the past, midcap funds have experienced extended periods of underperformance. That being said, good performance outweighs the underperformance periods. Overall, the best midcap funds have delivered excellent returns over the past decades.
However, the best midcap funds will not be appropriate if you are focused on short-term returns. In general, midcaps require a longer time horizon to achieve satisfactory returns. They have also fallen victim to market corrections more frequently than small-caps.
To summarise, the best midcap fund is ideally suited for long-term investors. If you don’t mind taking some risk, they can help diversify your portfolio.
A small-cap fund, on the other hand, is suitable for short-term investors. If you plan to buy stocks to sell them quickly, then small caps are ideal.
In terms of disadvantages, any small-cap fund has a higher risk profile. Since they are more volatile than midcaps, they tend to experience sharp price swings. Furthermore, unlike the best midcap fund, small caps don’t possess much inherent stability. They have less capacity to deliver consistent returns over a long period.
Both mid-cap and small-cap funds have their advantages and disadvantages. Before deciding where to invest, you need to understand the pros and cons of each category.
We suggest you do extensive research and analysis before investing your money. Also, as the market moves through cycles, you need to periodically rebalance your portfolio to ensure it matches your objectives.