Category : New to Investing February 13, 20265 minutes read
Large and mid cap mutual funds invest across both large cap and mid cap stocks, aiming to balance relative stability with long-term growth potential. As per SEBI regulations, these funds must allocate at least 35 percent of their corpus to each segment. This structured allocation creates a diversified equity portfolio but also exposes investors to market-related risks, making it important to understand the risk-return profile before investing.
The risk in large and mid cap funds arises mainly from equity market volatility and the inherent nature of mid cap stocks. Large cap companies are generally well-established, financially strong, and less volatile during market downturns. Mid cap companies, while offering higher growth potential, are more sensitive to economic cycles and investor sentiment, which can lead to sharper short-term fluctuations. By combining both segments, these funds aim to moderate overall risk while remaining equity-oriented and high-risk in nature.
Return potential is driven by the steady performance of large cap stocks and the growth contribution of mid cap stocks during favourable market conditions. Over long investment horizons, this balance may result in improved risk-adjusted returns compared to investing solely in one segment. These funds tend to perform differently across market cycles, offering growth participation during expansions and relative stability during slowdowns. As a result, large and mid cap funds may suit long-term investors with a moderate to high risk appetite.
Large and mid cap mutual funds are a type of investment scheme that invests in stocks of large and mid cap companies. The fund is mandated to invest at least 35% of its corpus in stocks of large and mid cap companies each. They aim to offer the dual benefit of investing in large cap stocks and potentially benefitting from stability and mid cap stocks that offer long-term growth potential. Nevertheless, as an equity scheme, the fund is vulnerable to certain risks, and investors must understand the risk-return profile of the scheme before investing. In this blog, we will discuss the risk-return profile of large and mid cap funds in detail.
Large and mid cap mutual funds are equity-oriented schemes that invest in a combination of large cap and mid cap companies. Large cap stocks belong to the top companies in terms of market capitalisation and are generally well-established, financially strong, and industry leaders. Mid cap stocks represent companies that are smaller but growing, often with higher expansion potential.
The mandatory allocation to both segments ensures diversification across company sizes, allowing investors to potentially gain exposure to both mature businesses and emerging growth opportunities.
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Risk in equity mutual funds primarily arises from market volatility, economic changes, and company-specific factors. In large and mid cap funds, risk is influenced by the characteristics of both large-cap and mid-cap stocks.
Large cap stocks are relatively less risky when compared to mid cap stocks. This is because the underlying companies have strong balance sheets, financial backing, and higher institutional ownership. They have the potential to be relatively stable even during market downturns. Contrarily, mid cap stocks are more sensitive to economic cycles and market sentiment, which can lead to sharper price movements and greater potential losses during market downturns. By investing in both segments, large and mid cap funds aim to moderate overall risk, though they remain high-risk investments due to their equity exposure.
Read more about the types of investment risks.
The return potential of large and mid cap funds comes from combining potentially steady large cap stocks with the growth opportunities of mid cap stocks. Large caps stocks have the potential to deliver consistent but moderate returns over time, while mid cap stocks have the potential to generate higher returns during periods of economic expansion. If mid cap stocks perform well, they have the potential to significantly enhance fund returns. At the same time, large cap stocks may potentially help stabilise performance during volatile periods. This combination may result in attractive long-term returns potential without extreme ups and downs that are generally found in pure mid cap and small cap funds.
Large and mid cap funds are mandated to invest 35% of their corpus in stocks of large cap and mid cap companies each. This requirement enforces a disciplined investment approach and prevents excessive concentration in a single market. The structured allocation may help balance the trade-off between risk and return. While mid cap exposure increases growth potential, large cap exposure may help reduce downside risk. The remaining portion of the portfolio allows fund managers flexibility to manage liquidity, valuations, and market conditions.
Large and mid cap funds tend to perform differently across market cycles. During bull markets, mid cap stocks have the potential to outperform due to faster growth and expansion. In such phases, large and mid cap funds have the potential to deliver strong returns driven by their mid-cap exposure. During bear markets or economic slowdowns, large-cap stocks have the potential to provide relative stability. Their strong fundamentals and market leadership help cushion the impact of market corrections, reducing overall portfolio volatility. This adaptability across cycles contributes to a more balanced risk-return profile over the long-term.
Despite their balanced structure, large and mid cap funds are vulnerable to short-term volatility. Mid cap stocks can experience sharp price movements in response to changes in investor sentiment, interest rates, or global events. This can lead to temporary fluctuations in fund value. However, diversification across market capitalisation and sectors helps manage volatility over time. Investors should be prepared for short-term ups and downs and focus on long-term performance rather than reacting to market noise.
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Risk-adjusted return is an important metric for evaluating equity funds. Large and mid cap funds aim to deliver risk-adjusted returns by smoothing volatility while capturing growth opportunities. Compared to pure mid cap funds, they may exhibit lower volatility. Compared to pure large cap funds, they may offer higher potential for wealth creation. Over long investment horizons, this balance may result in more consistent wealth creation, provided investors stay invested through market cycles.
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Time is a critical factor in equity investing. Large and mid cap funds may be suited for investors with a long-term investment horizon, typically five years or more. Longer holding periods allow short-term volatility to potentially even out and enable investors to benefit from the power of compounding. Short-term investors may experience unpredictable outcomes due to market fluctuations, while long-term investors may be better positioned to realise the intended risk-return balance of these funds.
Systematic Investment Plans (SIPs) may help manage risk in large and mid cap funds by spreading out investments over time. SIPs have the potential to reduce the impact of market timing risk, average purchase costs, and encourage disciplined investing. For volatile categories like large and mid cap funds, SIPs may be an effective way to navigate market fluctuations while potentially building long-term wealth.
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The risk-return profile of large and mid cap mutual funds reflects a strategic blend of stability and growth driven by their mandatory allocation to both large-cap and mid-cap stocks. While large cap exposure may help cushion volatility, mid-cap exposure may provide opportunities for wealth creation in the long run. These funds remain high-risk due to their equity orientation, making them more suitable for investors with a long-term horizon and the ability to withstand market fluctuations. Factors such as market cycles, volatility, investment horizon, and disciplined investing through SIPs play a key role in shaping outcomes. When approached with patience and realistic expectations, large and mid cap funds can serve as an effective component of long-term wealth creation.
