A mutual fund is a professionally managed company that collects money from many investors and invests it in securities such as stocks, bonds and short-term debt, equity or bond funds and money market funds.
Mutual funds are a good investment for investors looking to diversify their portfolio. Instead of betting everything on one company or sector, a mutual fund invests in different stocks to try to minimize portfolio risk.
The term is typically used in the US, Canada and India, while similar structures around the world include the SICAV in Europe and the open-ended investment firm in the UK.
What is the difference between mid-cap and small-cap funds?
If you have wondered whether mid-cap and small-cap funds are the same thing, you should definitely refer to the SEBI product categorization circular issued in October 2017 which came into force in June 2018. These are two different types of equity investment funds that invest in different types of companies, as defined by their market size, and therefore have different risk-return profiles.
There are many companies listed on the stock exchange on various stock exchanges in India. Mid-cap refers to the 101st to the 250th company in terms of market capitalization (market capitalization = number of shares listed on the stock exchange * price of each share) while the 251st company onwards in terms of market capitalization are called small caps.
A mid-cap fund invests in mid-cap companies that have high growth potential but do not show the risk associated with small capitals as these companies have already reached a certain scale and stability.
A small-cap
fund invests in small-cap companies that are currently experiencing high-potential growth but are just as risky. Unlike more stable large-cap stocks, small-cap stocks can be much more volatile.
So mid-cap funds have the potential to offer higher returns than large-caps without being too risky as the small-cap fund category. But they still have some element of risk that is higher than that of large-cap funds.
Given the type of stocks they invest in, both mid-cap and small-cap funds are risky in the short and medium term. These funds are suitable for young investors in case they wish to plan their long-term goals such as retirement, children’s education, etc. since they can afford to withstand the volatility of these funds over the horizon of 5-7 years. The reason for this volatility is that unlike bluechip stocks, the shares in the portfolio of these funds are still in the early growth phase and have not reached the stable growth phase of bluechip shares.
But this does not mean that all young investors in their 20s or 30s should have these funds in their portfolio. A young investor with moderate to high risk aversion should avoid them and instead stick to more stable large-cap funds or explore multicap funds that have exposure to large capital, mid-cap, and small caps in the same proportion.