Equity mutual funds are considered an ideal choice if you are aiming for long-term growth. Fund type varies depending on the size of the companies that the fund invests in. Mid cap and small cap funds are immensely popular options for investors seeking higher growth potential than large-cap funds.
Mid cap funds invest in medium-sized companies that can offer a good balance of risk and growth potential. Small cap funds invest in smaller companies with higher growth potential and greater risk. While the objective of both funds is to provide greater growth opportunities for investors, they differ significantly in terms of volatility and risk-return profiles. Understanding the differences is crucial to aligning your investments with your risk profile and financial goals.
What Are Mid Cap Funds?
Mid cap funds are the type of equity funds that primarily invest in medium-sized companies, ranked 101-250 by market capitalisation as per the guidelines of SEBI (Securities and Exchange Board of India). These are the established companies that are in their growth phase, expanding the market presence beyond the early stage of growth. Hence, these funds offer strong growth potential with relatively moderate risk in comparison to small-cap funds.
What Are Small Cap Funds?
Small cap funds are equity funds that primarily invest in smaller companies, ranked 251 and beyond by market capitalisation as per the guidelines of SEBI (Securities and Exchange Board of India). These are the companies that are in their early stage of growth or business cycle with higher expansion potential. As a result, small cap funds offer greater growth potential over the long-term, but with greater volatility and risk potential.
Mid Cap Funds Vs. Small Cap Funds: Key Differences
Here are the key differences between mid cap funds and small cap funds based on various factors:
| Factors | Mid Cap Funds | Small Cap Funds |
| Market capitalisation range | Medium-sized companies ranked between 101-250 by market capitalisation as per SEBI | Smaller-size companies ranked 251 and beyond by market capitalisation as per SEBI |
| Risk and volatility | Moderate to high risk and price volatility | Higher risk and price volatility |
| Growth potential | Stronger long-term growth potential with higher potential of expansion and becoming future market leaders | Very high long-term growth potential with higher potential to outperform the market as businesses are in their early stage |
| Liquidity | Liquidity is relatively better | Lower liquidity in comparison to mid-cap funds |
| Investment horizon | Medium to long-term (more than 5 or 7 years) | Long-term (more than 7 or 10 years) |
| Return potential | Lucrative return potential for long-term | Potentially higher return potential with higher volatility making them less predictable |
| Suitability | Investors seeking long-term wealth creation/growth with moderate to high risk | Aggressive investors seeking higher growth over long-term and comfortable with higher risk. |
Both mid cap and small cap funds offer strong growth opportunities, while they differ in risk exposure and stability.
Growth Potential Comparison
Mid cap companies are generally more established with a proven business model, but are still growing. These companies plan expansion and scale their operations to become large-cap companies in future. On the other hand, small cap companies are in their early-stage business growth with higher expansion potential over time.
As a result, growth consistency is relatively higher in mid cap funds, and small cap funds may offer higher but less predictable growth opportunities.
Risk and Volatility Comparison
Mid cap companies experience relatively less volatility with an established business model and stronger financial positions, helping them resist the market fluctuations. On the other hand, small cap companies are highly sensitive to market sentiments and economic conditions and may experience a sharper decline in price in comparison to mid cap stocks.
That means, mid cap funds offer a balance of growth, stability and risk, and small-cap funds may require investors to have higher risk tolerance and greater patience.
How Mid Cap Funds Identify Growth Companies?
Mid cap funds identify companies that are transitioning from mid-sized to large corporations, expanding their market presence, delivering consistent growth and earnings over the years. Generally, fund managers look at the following factors while identifying the growth companies:
- Scalability of the business model
- Strong leadership teams
- Consistency in earnings and operational efficiency
- Future potential to dominate the market or sector
For example, the HDFC Midcap Fund follows this strategy of identifying the mid cap companies with long-term growth potential and strong fundamentals to transition into well-established large corporations in future. Max Financial Services Ltd, AU Small Finance Bank Ltd, Fortis Healthcare and Hindustan Petroleum are some of the top holdings of HDFC Midcap Fund.
When Mid Cap Funds May Be Better?
Mid cap funds may be better in the following scenarios:
Scenario 1: Investors are seeking capital appreciation with moderate volatility, as the fund balances between growth potential and stability.
Scenario 2: Time horizon for the investor’s financial goal is medium to long term, between 5 and 7 years and more.
When Small Cap Funds May Be Better?
Small cap funds may be better in the following scenarios:
Scenario 1: Investors are seeking aggressive growth over the long term and are comfortable with higher volatility. Small-cap funds invest in companies that are aggressively expanding into new markets and developing innovative products. These businesses are highly sensitive to market sentiments, experiencing sharp price swings.
Scenario 2: The time horizon for the investor’s financial goal is long-term (10 years or more), as they need to have greater patience to ride through short-term market volatility for long-term growth.
Mid Cap or Small Cap Funds – Which is Better for Investors?
When it comes to investment, there is no ‘one size fits all’ solution. An ideal choice between mid cap and small cap funds depends on your financial goals, risk profile and investment time horizon.
Investors looking for a good balance between growth potential and stability with an investment horizon of medium to long-term can choose mid cap funds. While investors comfortable with high volatility and seeking aggressive growth over the long term may go for small cap funds. Diversifying the investment across various types of equity funds can help investors to manage risk better and create significant wealth.
Conclusion
To sum up, both mid cap and small cap funds offer compelling growth opportunities over the long term for wealth creation. Understanding the difference in risk, volatility and growth potential of both the options can help you make the right investment choice as per your risk-return profile and time horizon. Taking a diversified approach can be ideal for investors to build a well-balanced, long-term growth-oriented portfolio.