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Large, mid or small – which is your cap?

Whether you are cleaning up your equity mutual fund portfolios or starting fresh, one of the gnawing questions is always whether to add more large cap, mid cap or small cap schemes? Out of the three where should one invest ,or allocate higher amounts?

Equity markets have been rather volatile in the last few months, at the same time the correction in stock prices has provided investors with an opportunity to rethink allocations. Whether you are cleaning up your equity mutual fund portfolios or starting fresh, one of the gnawing questions is always whether to add more large-cap, mid-cap or small-cap schemes? Out of the three where should one invest, or allocate higher amounts?

The long term benefits

Ideally, you want your equity portfolio to deliver inflation plus returns over longer periods of 7-10 years. This is where equity mutual funds fit in and the right selection can help you achieve this objective simply by buying and holding the fund for the long-term period you have identified. 

While intuitively you may think that the return potential from small and mid-cap funds is substantially more than large-cap funds, you must consider that the risk is higher too. The higher risk translates into much sharper drawdowns during market corrections. 

You may get lucky in shorter periods where you are able to capture the high return and exit; if not then in longer periods, returns across the three categories are highly comparable. 

While returns from some funds in the small and mid-cap category have seen sharp uptrends too when the markets are rallying, on the whole, there is no evidence to show that in a ten-year kind of long period, small-cap funds outperform large-cap funds. 

The higher risk in small caps is also reflected in the interim volatility in returns seen across periods and across schemes. For example, in the last ten years, the top five best performing large-cap funds have delivered an average return of around 10% ranging from 11.5% to 9.5% annualised return. For the same period, the top five best performing small-cap funds have also delivered a similar average return, but in the range of 12%-7.5% annualised return. 

You may get lucky in shorter periods where you are able to capture the high return and exit; if not then in longer periods, returns across the three categories are highly comparable. 

The accurate metric

Instead of focusing on large, mid or small-cap look for schemes which have adequate diversification and a track record of consistent performance across market highs and lows. These are the funds which will have a higher probability of delivering your expected inflation plus return in any long-term period. 

Hence, consistency of performance, quality of the portfolio and the fund manager’s track record, are perhaps among the more accurate metrics to look out for in fund selection rather than the market capitalisation segment. 

Choosing the market capitalisation of your scheme is unlikely to add much to the long-term return of your portfolio. Focus on the more accurate metrics when you are making fund choices. 

 

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