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Small caps vs mid caps: Which equity funds offer more returns?

Investors keen on diversifying their investment portfolio with equity funds might find it confusing as to whether to invest their money in small cap, mid cap, or large cap. For those who aren’t aware, equity mutual funds are recognized based on the market cap which they choose to tap into to achieve their investment objective. The coronavirus outbreak had caused a serious impact on the performance of small, mid, and large cap stocks. The markets took over a year to recover and are now slowly gaining momentum across market capitalization.

Small cap funds are open ended equity funds that invest in companies that are worth Rs. 500 crore or less. These are companies that are either new to the market or are ranked beyond 250 in terms of market capitalization. Mid caps are funds which invest in mid cap company stocks. Large cap funds, also referred to as blue chip funds invest only in financially established companies that are market leaders.

Small cap funds

Small cap funds invest majority of its investible corpus is small cap companies. The stocks of small cap companies aren’t frequently traded like mid or large caps and hence offer lesser liquidity. Small cap companies are small time businesses, and this is why don’t attract the attention of institutional investors. Retail investors can make the most out of this opportunity and earn capital appreciation by investing in small cap funds for the long run. Since these funds invest in companies that are yet to earn a reputation for being financially well-established, investments in small cap funds is considered to be very risky.

Mid cap funds

Mid cap funds are open ended schemes that predominantly invest in mid cap company stocks. Mid cap companies are those organizations that are striving hard to become large caps. Retail investors can actually take advantage of this situation and invest in mid cap companies to earn long term capital appreciation. Mid cap stocks can either become small cap or large cap depending on how the company is able to generate profit and fare as compared to its competitors. The performance of a mid cap company stock can also be affected by the overall performance of the sector / industry to which it belongs.

Should you invest in mid caps or small caps for better returns?

Mutual fund investors must understand that irrespective of which equity scheme they invest in, it is impossible to earn gains over night. One must have the patience and persistence to continue investing for the long run or till their investment objective is accomplished. Small funds have historically offered far better returns than any other equity fund, sometimes even offer annual returns as high as 40 percent. However, since they invest in companies whose stocks aren’t traded as frequently as small caps or large caps, investors must understand that they are a high risk investment. On the other hand, mid cap schemes may not have offered returns as high as small caps, but they give investors a sense of relief by choosing those company stocks that have the potential to become large caps. Fund managers of mid cap funds choose stocks carefully to build a portfolio that will outperform its underlying benchmark and generate capital appreciation over the long term. Mid cap funds may not offer returns like small caps, but they are much more stable.

Investors who are willing to expose their finances to the dangers of market volatility can invest in small caps. On the other hand, those looking to invest in stocks that are more stable and less volatile than small caps can invest in mid cap funds. Do bear in mind that neither mid caps nor small cap funds offer guaranteed returns. Please consult a financial advisor before investing.

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