I am a 33 year old housewife. I wish to begin my investment journey by investing in mutual funds, however I am confused between largecap, midcap and smallcap mutual funds. Can you please elaborate on the major differences between the three categories of mutual funds?
Asha Nanda, Patna
In India, mutual funds are categorized as per the laws and regulations made by the Securities and Exchange Board of India (SEBI). Mutual funds on the basis of their market capitalization can be divided into three major categories: (a) largecap, (b) midcap and (c) smallcap.
Market capitalization is the total value of all of the shares of a listed company denoted often by the formula: Market capitalization = current value of a share of the company * total number of outstanding shares of the company.
Before understanding the difference between the three categories of mutual funds it is important that we understand the difference between the three categories of companies, which are classified as largecap, midcap and smallcap companies.
Largecap companies are those companies which constitute the top 100 listed companies of India in terms of market capitalization. Some examples of largecap companies are, Reliance, TCS, HDFC Bank, HUL, HDFC Limited, Bharti Airtel, Infosys, Kotak Mahindra Bank, and ITC
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Midcap companies are those companies which constitute the top 101st to 250th listed companies of India in terms of market capitalization. Some examples of midcap companies are LIC Housing Finance Company Limited, Glenmark Pharmaceutical Limited, Bank of India, Castrol India Limited, IDFC First Bank Limited,
Smallcap companies are all those companies which are not part of the top 250 companies of India in terms of market capitalization. Some examples of smallcap companies are 3I Infotech Limited, 5Paisa Capital Limited, Aditya Birla Money Limited, 63 Moons Technology Limited, etc.
Mutual Fund Classification
SEBI has classified mutual funds into 3 major categories basis their asset allocation into the 3 categories of companies, i.e., (a) largecap mutual funds, (b) midcap mutual funds, (c) smallcap mutual funds.
Largecap Mutual Funds
Largecap mutual funds are mandated under law to invest atleast 80 percent of their corpus into largecap companies, they have the leeway to further invest 20 percent of their corpus into largecap companies.
Midcap Mutual Funds
Midcap mutual funds are mandated under law to invest atleat 65% percent of their corpus into midcap companies, they have the leeway to further invest 20 percent of their corpus into midcap companies.
Smallcap Mutual Funds
Smallcap mutual funds are mandated under law to invest atleat 65% percent of their corpus into smallcap companies, they have the leeway to further invest 35% percent of their corpus into smallcap companies.
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The difference between the three
Please see below the key differences between the three categories:
Smallcap mutual funds are the riskiest, midcap mutual funds are relatively less risky, and largecap mutual funds are the least risky amongst the three if one analyse the historic performance of the three categories. Essentially the volatility of NAV of largecap mutual funds has historically has been the lowest.
Risk and return potential often go hand in hand in the stock market. Theoretically, smallcap mutual funds have the highest return potential, midcap mutual funds have relatively lower return potential, and largecap mutual funds have the lowest return potential. Essentially, historically in a bull market smallcap mutual funds have outperformed midcap and largecap mutual funds.
Investment in all three categories is taxed equally, long term capital gains are taxed at the rate of 10 percent, and short term capital gains is taxed at the rate of 15 percent. However, it is important to note that long term capital gains tax is exempt upto limit of INR 1 lakh for retail individuals.
An individual should choose the category of mutual fund in which he wishes to invest basis his own understanding of his risk profile. Investment in mutual funds are subject to market risk and one should invest in a mutual fund scheme only after reading the offer document carefully.
One has the option to invest in all three categories of mutual funds by allocating different quantums of his/her investment budget to three categories basis his/her risk appetite. Conservative investors very often invest only in largecap mutual funds whereas many young individuals invest heavily in smallcap mutual funds.
Note: This story is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.
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