Difference between Large Cap and Small Cap Funds
While part of the same universe, large cap and small cap funds cater to different audiences. So, as lucrative as small cap funds might seem, they might be too risky for conservative investors. Similarly large cap funds can feel lukewarm and underwhelming to aggressive investors. This is why understanding the meaning, basics, and differences between large cap and small cap funds is crucial before investing your hard-earned money.
The equity side of the mutual fund universe is divided into three categories based on market capitalisation - large cap, midcap and small cap. A large cap fund invests a significant portion of its assets under management (AUM) in stocks of large cap or blue chip companies. On the other hand, mid cap funds primarily invest in shares of mid-sized companies. Small cap funds typically invest a major chunk in small cap companies which are still in the start-up stage.
The core differentiation lies in the market capitalisation of the underlying stocks. Market capitalisation or market cap is the total market value of the outstanding shares of a particular company. For example, if company A has issued 2 lakh shares and the current market price is Rs. 100 per share, then the market capitalisation of the company will be Rs. 2,00,00,000.
At its core, the market capitalisation of a company is a key determinant of its valuation in the stock market at a particular point in time. Since market cap is one of the major barometers of the size, scale, and market strength of a company, it is used to bifurcate companies into three categories, namely large cap companies, mid cap companies, and small cap companies.
What Is Market Capitalisation?
Market capitalisation, commonly known as market cap or m-cap, is a key term used to describe the total market value of a company’s outstanding shares of stock. It is a straightforward calculation that helps investors understand a company's size in terms of its stock value.
Market capitalisation is important because it allows investors to compare companies of different sizes quickly and easily. It helps in understanding the risks and growth potential associated with investing in different companies. Larger companies are typically more stable, whereas smaller ones might offer more growth opportunities but come with higher risks.
The formula for market capitalisation is:
Market Capitalisation = Current Share Price × Total Number of Outstanding Shares
Essentially, it’s the value you would get if you multiplied the current price of a company’s stock by the total number of shares that the company has issued. Market cap is often used as a quick way to determine a company's size relative to others in the market.
For example; let’s assume Company XYZ has 1,00,00,000 (1 Cr) outstanding shares and the current market price of each share is ₹ 200. Using the formula, its market cap will be ₹ 200 Cr.
₹ 200 × 1,00,00,000 = ₹ 2,00,00,00,000
What are Large Cap Companies?
In the Indian stock market, companies are classified into three main categories based on their market capitalisation – large, mid, and small cap. This categorisation helps investors determine where a company fits in terms of size and risk profile. The first one is – large cap.
These are the largest and most well-established companies in the Indian market. Typically, companies with a market capitalisation of over ₹ 20,000 Cr fall in this category. Large cap or blue-chip companies are usually stable, diversified, well-known brands with a solid track record. They are less volatile and offer more stable investment options but may have slower growth compared to smaller companies. These companies also have a reputation of regularly paying dividends, adding to their attractiveness as a source of side income. Stock market indices like the Nifty 50 and BSE Sensex typically track large cap stocks.
Examples of Large Cap Stocks
Reliance Industries, Tata Consultancy Services (TCS), HDFC Bank, State Bank of India (SBI), and Infosys are some of the most prominent large cap companies in India.
What are Small Cap Companies?
Small cap companies are the smallest in the market in terms of capitalisation. Usually, these companies have a market capitalisation of less than ₹ 5,000 crores. Small cap stocks can be quite volatile and are often considered high-risk, high-reward investments. These companies might still be in the growth phase, and while they have the potential for significant returns, they are more prone to fluctuations in the market.
Another characteristic is that due to the size and influence of these companies, there is lesser information and analyst coverage available for them as compared to larger companies. Their liquidity can also be low making it difficult to sell you holdings when you want to. Nifty Smallcap 100 is a popular index that tracks the performance of small cap companies.
Examples of Small Cap Stocks
Notable small cap stocks include Godrej Industries Ltd, Aditya Birla Fashion and Retail Ltd, Bandhan Bank Ltd, Cholamandalam Financial Holdings Ltd, and One97 Communications Ltd (Paytm).
Large Cap Funds vs Small Cap Funds
| Parameter | Large Cap Funds | Small Cap Funds |
|---|---|---|
| Stability | Large cap funds are generally quite stable, especially in the long term, owing to the high degree of stability displayed by the stock of the underlying shares. | Small cap funds are generally less stable compared to large cap funds since the underlying companies are yet to establish themselves in the market. |
| Risk | Large cap funds carry a lower degree of risk than small cap funds because of the relative strength and market standing of underlying blue chip stocks. | Small cap funds carry higher risk as they invest in stocks of upcoming, start-up companies. |
| Return | The returns from large cap funds are usually moderate but consistent. The average return from large cap funds in the last five years has been 10.93%*. | The returns from small cap funds tend to be higher though not consistent. In the last 5 years, the average return of the small cap category has been 13.04%*. |
| Liquidity | Large cap funds enjoy easy tradability and high liquidity in the stock market. | Small cap funds, though liquid in their own right, carry less liquidity than their large cap counterparts. |
| Growth | Large cap funds have moderate growth potential since blue chip stocks have already achieved their growth spurt. | Small cap funds carry a higher growth potential since the underlying stocks are yet to establish themselves and experience their growth spurt. |
| Ideal for | Large cap funds are ideal for investors with a low-risk appetite and a medium-term investment horizon. | Small cap funds are ideal for aggressive investors with a long-term investment horizon. |
*return as on 14th November 2022
Both large cap and small cap funds have their merits, hence it is important to consider your financial goals, risk appetite, and time horizon before you invest in either of them. But whether you invest in large cap or small cap funds, it is crucial that you invest in direct mutual fund plans as you can potentially earn 1-2% additional returns. So, invest in the best mutual funds in India with m.Stock and earn 1-2% extra returns in addition to paying zero brokerage on delivery, IPO, Mutual Funds, ETFs, etc.
Balance Small Cap Funds And Large Cap Funds In Your Portfolio
Balancing your portfolio between small cap and large cap funds is crucial for maintaining both stability and growth. Each fund type serves a different purpose, and diversifying across them can help manage risks and enhance overall returns. Here are some tips and factors that should consider:
- Instead of putting all your money into either small cap or large cap funds, it's smarter to balance your portfolio. Diversifying your investments across small cap, large cap, and even mid-cap funds can help manage risk and improve overall returns.
- Large cap companies are generally more stable due to their financial strength and established market presence. Investing in large cap funds provides a solid foundation for your portfolio, offering consistent returns over time.
- Small cap funds can offer higher growth opportunities, especially when the economy is recovering from a downturn. These funds often outperform during economic recoveries but may be riskier during recessions due to higher volatility.
- Small cap funds tend to thrive when the economy is recovering from a recession, but they usually decline more during downturns. On the flip side, large cap funds are more stable during slow economic growth or market uncertainty, making them a safer bet during such times.
- If you're looking for regular income through dividends, large cap funds are often the better choice. These companies typically offer steady dividend payments thanks to their financial strength.
- Small cap funds are more suited to aggressive investors willing to take on higher risks for potentially higher returns. For conservative investors, large cap funds are a better fit due to their stability.
- Younger investors with a longer time horizon may opt for a higher allocation of small cap funds for growth. Older investors, closer to retirement, may prefer large cap funds for their reliability and lower risk.
- Small cap funds generally have higher fees, as they require more research and analysis. large cap funds often have lower expense ratios, making them more affordable to hold long-term.
By combining both small cap and large cap funds in your portfolio, you can enjoy the benefits of both stability and growth potential, ensuring your investments are well-diversified.
How To Choose Between Large Cap & Small Cap Funds
Selecting between large cap and small cap funds depends on your financial goals, risk tolerance, and investment horizon. Each type of fund offers unique benefits, and understanding these differences can help you make informed choices.
1. Risk Appetite
- Large Cap Funds: If you prefer lower risk, large cap funds are ideal. These invest in well-established companies that provide steady returns with less volatility.
- Small Cap Funds: Small cap funds suit those with a higher risk tolerance, as they invest in smaller, less stable companies that have potential for higher growth but also greater risk.
2. Investment Horizon
- Large Cap Funds: Suitable for short- to medium-term goals due to their stability. They are often chosen by investors nearing retirement or those seeking reliable returns in the near future.
- Small Cap Funds: Best for long-term investments. The potential for significant growth over time makes small cap funds appealing to younger investors with a long-time horizon.
3. Growth vs Stability
- Large Cap Funds: Offer steady and more predictable growth, making them a safer option for conservative investors.
- Small Cap Funds: Have greater potential for high growth but come with increased volatility. These funds can outperform large caps in a growing economy.
4. Income Needs
- Large Cap Funds: Ideal if you’re looking for dividend income. large cap companies often pay regular dividends due to their strong financials.
- Small Cap Funds: Generally, do not pay dividends, as smaller companies reinvest earnings for growth.
5. Economic Outlook
- Large Cap Funds: Perform better during economic slowdowns or uncertain markets, thanks to their established market presence.
Small Cap Funds: Can outperform during economic recoveries but tend to be more volatile during downturns.
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Capital markets have long been considered an excellent avenue for creating wealth. And one of the most popular investment instruments is equity shares. Investors can buy equity stocks directly from the market. But this can be risky due to lack of diversification and active management. So, as an alternative, investors choose mutual funds that invest in a basket of equity stocks. This results in diversification and active asset management. Equity mutual funds are bifurcated into three categories based on the market capitalisation of the underlying companies, namely large cap funds, mid cap funds, and small cap funds. Of these, large cap funds are extremely popular among conservative long-term investors, retirees and even stock market beginners with low-risk appetite.
FAQ
Which type of mutual fund (in terms of market capitalisation) is the most stable?
Large cap funds are generally more stable in comparison to small cap and mid cap funds owing to the financial stability of the underlying stocks.
Who can invest in small cap funds?
Any investor can invest in Small Cap Funds. However, such funds are ideal for investors with:
A long-term investment horizon
Expectation of high return
High risk tolerance