Investors have various financial objectives and risk preferences. Some may choose established companies, while others may look at mid-cap and small-cap companies for their potential to grow over time.
These companies are accessible through mid-cap and small-cap mutual funds. But there are also risks involved that investors should be aware of before investing.
What are mid-cap and small-cap funds?
Mid cap mutual funds and small cap mutual funds are mutual funds that primarily invest in companies on the basis of their market capitalisation. Mid cap means companies ranking 101st to 250th in terms of market cap, and small cap means companies ranking 250th and above.
Market capitalisation is the total market value of a company’s outstanding shares.
These companies are available to investors through a professionally managed portfolio in mid-cap and small-cap funds. They carry higher risks compared to large-cap funds.
A fund manager chooses stocks on the basis of factors such as business performance, growth prospects, valuations and the general market environment.
Rather than purchasing single stocks, investors get exposure to several companies in one mutual fund. This may offer diversification across different businesses within the segment.
Why do investors consider mid-cap and small-cap funds?
One of the key things investors look at when considering these funds is the potential for long-term growth. Mid- and small-cap companies may have more upside as their businesses grow and mature.
Potential for business growth
Revenue of a growing company may grow, new markets may be entered, new products may be launched, or market share may be gained. If the business is doing well, this growth could be reflected in its valuation over time.
But there are no assurances of growth. A company’s future performance is influenced by its business model, competition, industry conditions and management.
Portfolio diversification
When you purchase a fund, you’re purchasing a basket of stocks, not just one company.
This can help to spread company-specific risk across the portfolio. But diversification does not imply that one should avoid the risks that come with market movements or the mid and small cap segments.
What are the risks of mid-cap and small-cap funds?
More growth means more volatility, too. Market conditions change, and mid- and small-cap stocks may experience large price swings.
Larger companies may have more financial resources and more established business models than small-cap companies. This can make them more vulnerable to financial crises and changes in demand.
Market volatility
During times of market uncertainty, investors might gravitate toward more established companies. This can put some pressure on mid-cap and small-cap stocks.
This means that the value of these mutual funds can fluctuate quite a bit in the short term.
Valuation risk
High growth expectations could result in a high valuation for a company. If it fails to meet those expectations in reality, its share price may suffer.
So investors should look at valuations and business fundamentals rather than just expected growth.
How should investors approach these funds?
Investors should consider their financial objectives, investment time horizon and risk tolerance before investing in these funds.
These funds may be more suited to investors with a longer investment horizon who can remain invested in periods of volatility.
Consider a systematic investment plan
SIP allows investors to invest a fixed amount at regular intervals. This can help create investment discipline and prevent relying solely on a single entry point.
However, SIPs cannot guarantee returns and do not safeguard an investor from losses. The value of the investment will be subject to the performance of the underlying securities and will continue to be so.
Investors should check the fund’s portfolio, expense ratio, investment strategy, risk level and past performance before investing in mid-cap mutual funds.
Mid-cap vs small-cap funds: what is the difference?
The primary difference is the type of companies these funds invest in.
| Factor | Mid-Cap Funds | Small-Cap Funds |
| Company ranking | 101st–250th | 251st onwards |
| Business stage | More established | Generally less established |
| Growth potential | Potentially high | Potentially higher |
| Volatility | Can be high | Can be higher |
| Risk | High | Higher |
The best choice depends on an investor’s financial objectives and risk tolerance. Past performance is not indicative of future returns.
Conclusion
Mid-cap and small-cap funds offer exposure to companies with potential for long-term business growth. They can also contribute to diversification with a professionally managed portfolio.
At the same time, these funds can have higher volatility and greater risks than large-cap-focused investments. Investors should consider their investment objectives, time horizon and risk tolerance before investing.
