Investing? Better be cautious!

Initial public offerings have managed to catch the fancy of both asset management companies as well as investors. But the recent slew of IPOs is more of the 'unconventional' type vis-à-vis the plain vanilla ones.

Mid-cap funds, flexi-cap funds and sector funds have been hitting the markets like never before. But do investors really understand how different these funds are from the ones currently in existence?

In this article, we have evaluated the various options available to the investor based on market capitalisation. Market capitalisation is defined as number of shares outstanding multiplied by the current share price.

Large cap funds
Large cap funds invest their money primarily in companies, which have a sizable market capitalisation. 'Sizable' is defined differently by different fund houses. This is usually mentioned in the fact sheets for the investor's benefit. For instance, in its recent IPO (Franklin Flexi Cap), Franklin Templeton defined large caps as companies with a market capitalisation in excess of Rs 1,500 crores (Rs 15 billion). Companies below this threshold were categorised as mid/small caps. Investing in large caps is a lower risk return proposition (vis-à-vis mid cap stocks), because such companies are usually widely researched and information is widely available.

HDFC Top 200 Fund, Franklin India Bluechip Fund, HSBC Equity Fund for instance, invest predominantly in large caps.

Get the leading large cap funds over here.

Mid cap funds
These funds invest in companies that have a lower market capitalisation than the large caps. For instance, Sundaram Mutual Fund defines mid caps as stocks with a market capitalisation of less than Rs 1800 crores (Rs 18 billion). However, this level varies from fund house to fund house.

As with large caps, BSE (BSE Mid Cap 200) and S&P CNX (S&P CNX Mid Cap 200) have designed their own indices for mid cap stocks. Many mid cap funds benchmark their performance against these indices, which also serves as a reliable investment universe for their own funds.

Investments in mid caps are a riskier proposition as compared to investments in large cap funds. There are several reasons for the same. One, the mid cap companies are usually under-researched. Two, such companies tend to be illiquid as they have a smaller market capitalisation. This in turn leads to above-average volatility. Fund managers often find it difficult to exit these stocks in a falling market or enter when interest in the stock is building up.

The upside -- the fund can generate a superior return as mid cap stocks have the potential to give a higher return vis-à-vis

large cap companies. This is mainly because many of these companies are in a growth phase as opposed to large caps that have attained relative stability. In fact, a mid cap stock could well graduate to a large cap over the years giving the investor a significant return on his investment. Franklin India Prima Fund, Magnum Global Fund, Sundaram Select Mid Cap fund are some examples of mid cap funds.

Small cap funds
As the name suggests, small cap funds invest in companies with a smaller market capitalisation. In its recently concluded IPO (Sundaram SMILE) -- Sundaram Mutual Fund defined small caps as stocks with a market capitalisation of less than Rs 200 crore (Rs 2 billion). Investing in small cap funds is fraught with considerable risk.

To begin with, small cap companies in most cases are just evolving. Again, as with mid caps, information on small caps is not easily available so these companies are under-researched or maybe not researched at all. So we are contending with a relatively unknown entity here. However, the risk-return trade-off is much higher vis-à-vis large caps and mid caps.

Currently this is a niche segment as there is no fund investing purely in small cap stocks. Sundaram SMILE is probably the first small cap fund of its kind.

Multi/Flexi-cap fundsJust about every second mutual fund IPO these days is a multi/flexi cap fund. The fund manager has the mandate to shift across market capitalisations depending on the growth opportunity. This is generally dictated by the 'flavour of the day' i.e. which sector is driving growth at a given time or which market segment (market capitalisation) is witnessing the latest rally.

But generally, there's a ceiling on how far the fund manager can go in a particular market segment or sector. This helps in keeping the portfolio relatively diversified and mitigate risks. In terms of risk-return trade-off, these funds are positioned between large caps and mid caps.

Some multi cap funds include -- DSP ML Opportunities, Tata Equity Opportunities, Principal Resurgent India Fund.

To put things in perspective, none of the abovementioned funds can be classified as good or bad investment options. It depends on the risk appetite of the investor as well as how well-informed he is about a particular sector, market segment and companies within that segment. Therefore, it makes sense for an investor to diversify his mutual fund portfolio and include various types of funds without deviating from one's risk profile.

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