For those sifting through the multitude of fund types when deciding on an equity mutual fund, the terms large-cap, mid-cap, small-cap make a repeated appearance. If you are unsure what the term “cap” has to do with mutual funds, don’t worry. Here’s a simple guide to understanding the whole thing.
What does the word “cap” refer to?
Cap is short for capitalisation or rather Market Capitalisation. This is nothing but the total market value of the shares of a company that is listed on the stock market. Total no. of shares of the company X current market price of the share.
All the super-rich that you hear about who are worth billions – that number is largely made up of market value of their shares in the companies they founded. This is why it keeps moving with the market and they can, overnight, lose or make billions because the stock market crashed or jumped up.
Yesterday’s mid-caps are today’s large caps and what used to be large caps are small caps today. Here are some examples of companies that lost significant market capitalisation: Reliance Communications, Sintex Industries, Manpasand Beverages. At the same time, here are some examples of companies that built up Market capitalisation to become giants: Bajaj Finance, V-Guard, Titan.
So what does Large cap mean?
Large-cap refers to the largest companies listed on the stock exchange in order of their market capitalisation. For the purpose of Indian mutual funds, the list is comprised of the 100 largest companies on the index. These are some of the biggest companies in India. Reliance Industries, TCS, and HDFC are the top three. The last on the list has a market cap of Rs 28,000 Cr. These numbers are as of 30th June 2019. Large-Cap Equity MFs primarily invest in such companies.
With size comes stability & predictability of revenue & growth. This usually means lower price fluctuation. The growth rate in these shares is somewhat more predictable which places some limits on the rate of increase in their value over time.
Large cap companies also tend to have much larger number of shares available for trading, therefore you can buy and sell large number of shares without any issue. This is called liquidity.
Bottomline: Large, proven, successful companies. Slow but steady growth. Lower volatility considering the asset class. There shares are liquid. Most likely to survive economic downturns.
And what are mid-caps?
The next 150 companies in terms of market capitalisation are called mid-caps. These are smaller companies but still worth at least about Rs 9,000 Cr (according to AMFI data dated 30th June 2019). Canara Bank, Mindtree, Ashok Leyland are good examples of mid-caps. Mid-cap Equity MFs invest primarily in such companies.
These companies have a stable business model but are yet to achieve scale or large numbers in terms of important metrics like sales or customers. The growth rate in the value of the shares of such companies can be high but far more uncertain.
Companies tend to move across market caps and in both directions. Only 15 companies, out of the thousands that were listed, have remained a part of the Nifty 50 index since inception.
Bottomline: Companies that are generally successful but have not become market leaders yet. Can be high growth. Can show higher volatility within the asset class. Stable business model but yet to scale. Generally liquid. Most can survive bad times.
What about small-caps?
Anything below mid-caps in terms of market capitalisation is considered small cap. The overwhelming majority of companies on any stock exchange are small caps. These are companies that are in the early stages and are still finding their feet in terms of a business.
The largest small cap is a company (Schaeffler India) that has a market cap of 8,800 Cr as of 30th June 2019. Other examples are Blue Dart and Finolex Cables. Small-cap Equity MFs invest primarily in such companies. The growth rate in the value of such companies can be extraordinary in some cases but also comes with the greatest uncertainty.
Bottomline: Companies that are generally small or young and could be in niche industries. Can be high growth but also high risk from a failure perspective. Can show the highest volatility within the asset class. Liquidity risk. Sensitive to economic cycles and circumstances.
As you may have noted, to some extent the dividing line is arbitrary and the largest small caps are a bit like the smaller mid caps - just as the larger mid caps are like the smaller large caps.
- What you invest in will, as usual, depend on your financial goals but generally a good long-term goals oriented portfolio consists of all three types in varying quantities. However, just because a company is large cap doesn’t automatically means it is good for your investments. Some large cap firms are in the ascent and others in descent which will be tomorrow’s mid-caps or small caps. It’s one of the many tasks of a mutual fund manager to figure out which are which.
- Companies tend to move across market caps and in both directions. Only 15 companies, out of the thousands that were listed, have remained a part of the Nifty 50 index since inception.
- Yesterday’s mid-caps are today’s large caps and what used to be large caps are small caps today. Here are some examples of companies that lost significant market capitalisation: Reliance Communications, Sintex Industries, Manpasand Beverages. At the same time, here are some examples of companies that built up Market capitalisation to become giants: Bajaj Finance, V-Guard, Titan.
- Not every company will grow and become a vaunted large cap and remain there. The job of a good fund manager is to discover and invest in companies that will multiply your wealth over a period of time and do so consistently.