Are you planning to invest in equity mutual funds? It’s often said that these funds can be riskier than debt mutual funds, but how risky are they?
The extent of risk in mutual funds depends on the market capitalisation. Whether the mutual funds are small-cap, mid-cap, or large-cap would determine their risk profile and suitability to your risk appetite.
Market capitalisation, often called “market cap,” is the total market value of a company’s outstanding shares. It plays a crucial role in determining the risk and potential mutual fund return of equity mutual funds in India.
In simple terms, mutual funds India can offer a diversified approach to investing in the stock market. However, understanding the relationship between market capitalisation and risk is crucial for making informed investment decisions.
In this blog, we’ll explore the three main segments of market capitalisation and examine how market cap can influence mutual fund risks and returns.
Understanding Market Capitalisation
Market capitalisation categorises companies into three main segments:
1. Large-Cap
These are well-established, large companies with a proven track record and generally stable performance. They typically have a market cap of ₹20,000 crores or more.
2. Mid-Cap
These are mid-sized companies with growth potential but may carry higher risks than large-cap companies. Their market cap typically ranges between ₹5,000 crores and ₹20,000 crores.
3. Small-Cap
These are smaller companies with higher growth potential but also higher risk and volatility. They usually have a market cap below ₹5,000 crores.
How Market Cap Influences Mutual Fund Risk and Return
The market cap of the underlying stocks in a mutual fund India significantly influences its risk and return profile.
Here’s how they impact the risk and potential return matrix:
(A) Large-Cap Funds
1. Lower Risk
Large-cap companies are generally more stable and less volatile than mid-cap and small-cap companies. As a result, large-cap mutual funds India have a lower risk compared to the mid-cap and small-cap counterparts.
2. Moderate Return
While large-cap funds may not offer explosive growth, they generally provide stable and consistent mutual fund returns over the long term.
3. Suitable For
These could be better for conservative investors with a longer investment horizon seeking steady growth and capital preservation.
Example
A large-cap fund investing in established companies like Reliance Industries, HDFC Bank, and Infosys will likely offer relatively stable returns with lower volatility.
(B) Mid-Cap Funds
1. Moderate Risk
Mid-cap companies strike a balance between growth potential and risk. These companies can experience higher growth than large-cap companies. However, they are vulnerable to market fluctuations.
2. Higher Return Potential
Mid-cap funds have the potential to generate higher mutual fund returns compared to large-cap funds but with higher risk.
3. Suitable For
These can be better for investors with a moderate risk appetite and a longer investment horizon seeking a balance of growth and stability.
Example
A mid-cap fund investing in companies like Adani Green Energy, Tata Power, or Jubilant FoodWorks might offer higher growth potential but greater volatility than a large-cap fund.
(C) Small-Cap Funds
1. Higher Risk
Small-cap companies are inherently riskier due to their smaller size, limited financial resources, and greater susceptibility to market downturns.
2. Highest Return Potential
Small-cap funds have the potential to generate the highest mutual fund returns among the three categories, but they also carry the highest risk.
3. Suitable For
This can be better for investors with a high-risk appetite and a long-term investment horizon seeking aggressive growth.
Example
A small-cap fund investing in emerging companies with high growth potential might experience significant volatility and fluctuations in mutual fund return.
Research and Statistics
A study by Morningstar titled “Equity Fund Performance: Large vs. Mid vs. Small” revealed that while small-cap funds have historically generated higher returns than large-cap funds, they tend to be more volatile and carry significant risk.
Research by CRISIL, a leading credit rating agency in India, found that mid-cap funds blend risk and return proportionately, potentially outperforming large-cap funds over the long term while carrying moderate risk.
Factors Beyond Market Cap
Even though market capitalisation is a critical factor in determining risk, let’s take a look at other factors that can affect mutual fund returns:
- Investment Style: A fund’s investment style—growth, value and blend—can impact its risk profile and return potential.
- Fund Manager Expertise: A skilled fund manager can navigate market volatility and generate consistent returns, regardless of market cap focus.
- Economic Conditions: Macroeconomic factors like interest rates, inflation, and GDP growth can impact the performance of all funds, regardless of market cap.
- Sector Concentration: Funds focussed on specific sectors tend to be more volatile than diversified funds.
Pro Tip: Create wealth with SIP. Start now.
Wrapping Up
When choosing mutual funds India, it’s crucial to understand the connection between market capitalisation and risk. Large-cap funds are often known for their stability and lower risk since they invest in well-established companies. On the other hand, small-cap funds offer higher growth potential but with higher risk. Mid-cap funds strike a balance between the two, offering growth potential and moderate risk.
By carefully considering your risk tolerance, investment goals, and time horizon, you can choose mutual funds India with an appropriate market cap allocation to maximise your mutual fund return potential while managing risk effectively.
Interested in how we think about the markets?
Read more: Zen And The Art Of Investing
Watch here: Is UPI Killing the Toffee Business?
